Valuation of Put Options on Leveraged Equity
This paper presents new closed form solutions for the valuation of European put options and of "down-an-in" barrier options written on leveraged equity. Unlike in past literature (Toft and Prucyk, 1997) and in keeping with empirical evidence, the model allows equity to retain value even after the firm's default and reorganisation. This stylised fact can significantly alter the valuation of equity put and "down-and-in" options as bankruptcy costs, bargaining power of equity holders, debt maturity and other firm parameters change. The value of "in-the-money" puts often decreases in the firm's assets volatility. The model can produce a variety of realistic implied equity volatility "skews".
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