Level Dependent Annuities: Defaults of Multiple Degrees
Posted: 5 Mar 2007 Last revised: 9 May 2012
Date Written: March 3, 2008
Motivated by the risk of stopped debt coupon payments from a leveraged company in ïB01nancial distress, we value a level dependent annuity contract where the annuity rate depends on the value of an underlying asset-process. The range of possible values of the asset is divided into a ïB01nite number of regions. The annuity rate is constant within each region. Such annuities are common in models of debt with credit risk in ïB01nancial economics.
Suspension of debt service under the US Chapter 11 provisions is one well-known real-world example. We present closed-form formulas for the market value of multi-level annuities contracts when the market value of the underlying asset is assumed to follow a geometric Brownian motion.
Keywords: multi-level annuity, credit risk, financial distress, barrier options
JEL Classification: G33, G13, G32
Suggested Citation: Suggested Citation