Pricing vulnerable options under correlated skew Brownian motions

Abstract

AbstractIn this paper, we consider vulnerable options in a pricing model with correlated skew Brownian motions. In the proposed pricing model, both the underlying asset and option issuer's assets are exposed to endogenous and exogenous risks. We deduct a new pricing formula of vulnerable European options, and then use it to illustrate the effect of the skewness parameters on vulnerable option prices. An interesting finding is that vulnerable option prices are higher when the variance of the logarithm of option issuer's assets is larger in some cases.