Details

Title

Indifference pricing with counterparty risk

Journal title

Bulletin of the Polish Academy of Sciences: Technical Sciences

Yearbook

2017

Numer

No 5

Publication authors

Keywords

General Engineering ; Computer Networks and Communications ; Atomic and Molecular Physics, and Optics ; Artificial Intelligence ; Information Systems

Divisions of PAS

Nauki Techniczne

Abstract

<jats:title>Abstract</jats:title><jats:p>We present counterparty risk by a jump in the underlying price and a structural change of the price process after the default of the counterparty. The default time is modeled by a default-density approach. Then we study an exponential utility-indifference price of an European option whose underlying asset is exposed to this counterparty risk. Utility-indifference pricing method normally consists in solving two optimization problems. However, by using the minimal entropy martingale measure, we reduce to solving just one optimal control problem. In addition, to overcome the incompleteness obstacle generated by the possible jump and the change in structure of the price process, we employ the BSDE-decomposition approach in order to decompose the problem into a global-before-default optimal control problem and an after-default one. Each problem works in its own complete framework. We demonstrate the result by numerical simulation of an European option price under the impact of jump’s size, intensity of the default, absolute risk aversion and change in the underlying volatility.</jats:p>

Publisher

Polish Academy of Sciences

Date

2017

Identifier

ISSN 0239-7528, eISSN 2300-1917

DOI

10.1515/bpasts-2017-0074

×