Valuation of European Options Subject to Financial Distress and Interest Rate Risk

Posted: 3 Apr 1999

See all articles by Peter Klein

Peter Klein

Simon Fraser University (SFU) - Finance Area

Michael Inglis

Ryerson University - Ted Rogers School of Management

Abstract

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

Klein, Peter Charles and Inglis, Michael, Valuation of European Options Subject to Financial Distress and Interest Rate Risk. Journal of Derivatives, Spring 1999. Available at SSRN: https://ssrn.com/abstract=151678

Peter Charles Klein

Simon Fraser University (SFU) - Finance Area ( email )

Burnaby, British Columbia V5A 1S6
Canada
604-291-5605 (Phone)

Michael Inglis (Contact Author)

Ryerson University - Ted Rogers School of Management ( email )

350 Victoria Street
Toronto, Ontario M5B 2K3
Canada
416-979-5000 ext. 6723 (Phone)
416-979-5266 (Fax)

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