Pricing Counter-Party Risk Using Good Deal Bounds
40 Pages Posted: 24 Feb 2008 Last revised: 12 Sep 2014
Date Written: August 4, 2014
Abstract
We analyze the problem of pricing counter-party risk for over-the-counter derivatives when there is no liquidly traded credit derivative for the counter-party. We address the market incompleteness by computing good deal bounds. We show that the lower good deal bound is a coherent risk measure and, that the good deal bound interval can be used to assess model risk. Together, these answer the question of how much the price of an OTC derivative can change due to a re-pricing of credit risk on the market or due to a change in risk attitudes and of how much we can trust the numbers we obtain from pricing counter-party risk for firms for which we do not have a liquidly traded credit derivative.
Keywords: incomplete markets, good deal bounds, vulnerable options, counterparty risk, coherent risk measure, over-the-counter derivatives market
JEL Classification: C61, G13, G19
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Recommended Papers
-
Beyond Arbitrage: 'Good Deal' Asset Price Bounds in Incomplete Markets
-
Beyond Arbitrage: "Good-Deal" Asset Price Bounds in Incomplete Markets
-
Losing Money on Arbitrage: Optimal Dynamic Portfolio Choice in Markets with Arbitrage Opportunities
By Jun Liu and Francis A. Longstaff
-
By James Dow and Gary B. Gorton
-
Generalized Sharpe Ratios and Asset Pricing in Incomplete Markets
By Aleš Černý
-
The Theory of Good-Deal Pricing in Financial Markets
By Aleš Černý and Stewart D. Hodges
-
Imperfect Arbitrage with Wealth Effects
By Wei Xiong
-
Towards a General Theory of Good Deal Bounds
By Tomas Bjork and Irina Slinko