The pricing of vulnerable options with double Mellin transforms

Abstract

Many options traded in the over-the-counter markets are subject to default risks resulting from the probability that the option writer could not honor its contractual obligations. There have been growing concerns about financial derivatives subject to default risks, in particular, since the Global Financial Crisis and Eurozone crisis. This paper uses double Mellin transforms to study European vulnerable options under constant as well as stochastic (the Hull–White) interest rates. We obtain explicitly an analytic closed form pricing formula in each interest rate case so that the pricing of the options can be computed both accurately and efficiently.