A closed-form solution for pricing European-style options under the Heston model with credit and liquidity risks
A study derives a closed-form pricing solution for European options under the Heston model, integrating credit and liquidity risks.
What it examines
This study introduces a closed-form solution for pricing European-style options using the Heston model. It integrates credit risk and market-wide liquidity risk through stochastic factors. The method aims to accurately capture hazardous financial risks and enhance option pricing in volatile markets.
What it concludes
The closed-form solution increases pricing accuracy by integrating credit and liquidity risks in a Heston framework. Its results have practical applications in derivative pricing, risk management, and portfolio hedging. Future research should address model simplifications and extend usage to broader market conditions, aiding financial institutions in more robust risk evaluation.
Evidence objects
The study extends the Heston model by incorporating credit and liquidity risks, providing a closed-form solution that improves European option pricing accuracy through modeling credit risk driven by market liquidity.
key_findings bullet 1 · key_findings · validation V0
Integrating credit risk as a stochastic factor directly linked to market liquidity challenges traditional models. Novel analytical techniques capture the dynamic interplay, streamlining computations and significantly enhancing risk management insights.
key_findings bullet 2 · key_findings · validation V0
Despite robust derivations, the study concedes limited empirical testing and calibration data. It warns that ignoring liquiditys effect on credit risks may lead to underpricing, urging additional rigorous empirical validation.
key_findings bullet 3 · key_findings · validation V0
This paper extends the popular \$Heston\$ model by incorporating novel credit and liquidity risk factors, providing a closedform solution for pricing European-style options. It offers an innovative methodological twist while addressing practical concerns in derivative pricing. Although incremental, its approach delivers valuable insights and significant technical contributions to volatility modeling.
key_findings bullet 4 · key_findings · validation V0
Raw abstract and provenance
- … Credit risks are one type of hazardous financial risks, which results in the necessity of … via a stochastic factor relying on stochastic market-wide liquidity. We then develop a …
Source row: 8 · abstract type: snippet