Valuation of European Options Subject to Financial Distress and Interest Rate Risk
Posted: 3 Apr 1999
This article develops a simple framework for valuing options subject to interest rate risk and to the risk of financial distress on the part of the option writer. The framework is used to derive analytical expressions for European calls and puts that allow for correlations among the process driving financial distress, the value of the asset underlying the option, and the risk-free interest rate. Numerical examples demonstrate the importance of these correlations when valuing these instruments.
JEL Classification: G13
Suggested Citation: Suggested Citation