Improved lower bounds of call options written on defaultable assets

Greg Orosi
2014 Journal of Derivatives & Hedge Funds  
is currently an Assistant Professor in the Department of Mathematics and Statistics at the American University of Sharjah. He holds a PhD in Applied Mathematics with a specialization in mathematical finance from the University of Calgary. His research areas include computational finance and applications, numerical methods applied to derivative pricing, empirical performance of option pricing models and non-parametric modeling. ABSTRACT This article provides an improvedmodel-independent lower
more » ... nd of European call options written on defaultable assets. On the basis of static arbitrage arguments, improved lower bounds are established, which also depend on the probability of option-implied default. The results are also extended to dividend-paying stocks. Moreover, our findings imply that it is never optimal to exercise certain American call options. Finally, we discuss the implications of our results for constructing an arbitrage-free volatility surface and extracting risk-neutral densities from option prices.
doi:10.1057/jdhf.2014.14 fatcat:j3zndwaqnvfgrolahgeims7c7u