Equity Options and Bond Options in the Leland Model

43 Pages Posted: 8 Mar 2011 Last revised: 14 Feb 2012

See all articles by Gaia Barone

Gaia Barone

School of Business, National College of Ireland

Date Written: April 2011

Abstract

We reviewed (extended and made more compact/self-explained) some formulas, previously appeared in the literature, for the evaluation of equity options and bond options in the Leland model (1994), where stockholders have a perpetual American option to default.

Our formulas have been expressed in terms of binary barrier options, using the results obtained by Rubinstein and Reiner (1991). We also used the results obtained by Barone (2010), where it has been proved that perpetual American options follow a geometric Brownian motion, under the standard Black-Scholes-Merton assumptions.

We generalized the formulas for bond options and extended the formulas for both equity and bond options to the case of premature expiry of the contracts at the time of default. Besides, we derived a simple put-call parity for both equity options and bond options. These relationships allow to check our formulas.

Keywords: perpetual American options, binary barrier options, first-touch digitals, put-call parity

JEL Classification: G13

Suggested Citation

Barone, Gaia, Equity Options and Bond Options in the Leland Model (April 2011). Available at SSRN: https://ssrn.com/abstract=1779303 or http://dx.doi.org/10.2139/ssrn.1779303

Gaia Barone (Contact Author)

School of Business, National College of Ireland ( email )

Mayor Street
IFSC
Dublin, 1
Ireland

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