Vulnerable Exotic Derivatives
In: The Journal of Derivatives, Vol. 24, No. 3, pp. 84-102
Category: Publications in scientific journals [Find it]
In this article, we study the impact of unilateral and bilateral counterparty risk on exotic derivatives. The default risk of a counterparty on over-the-counter transactions has gained relevance worldwide, particularly after the subprime and financial crisis with the default of Lehman Brothers. Since the early work of Black and Cox , the default risk of a corporation is known to be representable as a barrier-type product with a sound financial footing involving assets and liabilities. Here, we present closed-form mathematical solutions for
exotic products in the framework of n assets under unilateral and bilateral counterparty risks, such as vulnerable barrier options, vulnerable spread options, and defaultable swaps. The findings show that, in realistic situations, price changes could be up to 20%, owing to unilateral and/or bilateral risks on exotic products.
Reference No.: 2017-103