Pricing Discrete Barrier Options and Credit Default Swaps Under Levy Processes

63 Pages Posted: 10 Jun 2012

See all articles by Marco de Innocentis

Marco de Innocentis

Credit Suisse Securities (Europe) Limited; University of Leicester

Sergei Levendorskii

Calico Science Consulting

Date Written: June 8, 2012

Abstract

We consider discretely monitored barrier options under Levy models, including single and double barrier options and first touch digitals, as well as CDS and defaultable bonds. At each step of backward induction, we use piece-wise polynomial interpolation and an efficient version of the Fourier transform techniques, which allows for efficient control of errors. We derive accurate recommendations for the choice of parameters of the numerical scheme, and produce numerical examples showing that oversimplified prescriptions in other methods can result in large errors.

Keywords: Barrier options, credit default swaps, CDS, defaultable bonds, discrete monitoring, credit derivatives, Greeks, inverse Fourier transform, FFT, Hilbert transform, CONV method, COS method, Levy processes, KoBoL processes, CGMY model, Variance Gamma processes

JEL Classification: G12, C63

Suggested Citation

de Innocentis, Marco and Levendorskii, Sergei Z., Pricing Discrete Barrier Options and Credit Default Swaps Under Levy Processes (June 8, 2012). Available at SSRN: https://ssrn.com/abstract=2080215 or http://dx.doi.org/10.2139/ssrn.2080215

Marco De Innocentis (Contact Author)

Credit Suisse Securities (Europe) Limited ( email )

1 Cabot Square
London, E14 4QJ
United Kingdom

University of Leicester ( email )

Department of Mathematics
University Road
Leicester, LE1 7RG
United Kingdom

Sergei Z. Levendorskii

Calico Science Consulting ( email )

Austin, TX
United States

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