The Pricing of Bermudan Options on Defaultable Bonds
نویسندگان
چکیده
The Pricing of Bermudan Options on Defaultable Bonds In this paper, we modify the Nelson and Ramaswamy (1990)-Ho, Stapleton and Subrahmanyam (1995) diffusion approximation. The modification allows the approximation of correlated lognormal diffusion processes. The general method is illustrated by pricing a Bermudan-style put option on the minimum of two asset prices. We then apply the method to price options on defaultable bonds. The yield on the bond is modelled in terms of a lognormal risk-free interest rate and a correlated lognormal credit-spread factor. The properties of the bivariate lognormal diffusion are employed to ensure rapid computation for realistic problems. Bermudan-style options on defaultable bonds are priced, and the effect of the volatility and correlation of the credit spread is investigated. Model for Pricing Options on Defaultable Bonds 1
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