The credit risk and pricing of OTC options

Journal article

In the over-the-counter (OTC) markets, the options traded are always subject to credit risk. Therefore the counterparty's credit risk is a striking factor when pricing options, whereas it is not considered in the classic Black-Scholes models. Based on the first passage time models, this paper develops the credit risk and valuation model for the European options in the OTC markets, incorporating a practical default trigger mechanism. The default probability and the pricing formulae of the OTC options are obtained by using partial differential equation (PDE) techniques, especially Green's function. © 2007 Springer Science+Business Media, LLC.

Authors: Liang, G; Ren, X

• Journal: Asia-Pacific Financial Markets
• Volume: 14
• Issue: 1-2
• Pages: 45-68
• Publication date: 2007-03-01
• DOI: 10.1007/s10690-007-9053-x
• EISSN: 1573-6946
• ISSN: 1387-2834
• Language: English
• Keywords: Default probability; OTC options; Green's function; Valuation; Credit risk