Analytical valuation of power exchange options with default risk

Abstract

In this paper, we provide an analytical valuation formula for power exchange options with default risk. The proposed model not only considers the correlations among the two underlying assets and the asset of the counterparty, but also allows for the possible default prior to the maturity of the option. We decompose the risk of all assets into idiosyncratic and systematic parts. By means of the measure-change technique, we obtain a pricing formula for power exchange options with default risk. Finally, numerical results are presented to show the power exchange option values.