A simple robust link between american puts and credit protection

Peter Carr, Liuren Wu

Research output: Contribution to journalArticle

Abstract

We develop a simple robust link between deep out-of-the-money American put options on a company's stock and a credit insurance contract on the company's bond. We assume that the stock price stays above a barrier B before default but drops below a lower barrier A after default, thus generating a default corridor [A,B] that the stock price can never enter. Given the presence of this default corridor, a spread between two co-terminal American put options struck within the corridor replicates a pure credit contract, paying off when and only when default occurs prior to the option expiry.

Original languageEnglish (US)
Pages (from-to)473-505
Number of pages33
JournalReview of Financial Studies
Volume24
Issue number2
DOIs
StatePublished - Feb 2011

Fingerprint

Credit
American put option
Stock prices
Insurance contract

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this

A simple robust link between american puts and credit protection. / Carr, Peter; Wu, Liuren.

In: Review of Financial Studies, Vol. 24, No. 2, 02.2011, p. 473-505.

Research output: Contribution to journalArticle

Carr, Peter ; Wu, Liuren. / A simple robust link between american puts and credit protection. In: Review of Financial Studies. 2011 ; Vol. 24, No. 2. pp. 473-505.
@article{f1f64a6b2e374058ac25ed6821119526,
title = "A simple robust link between american puts and credit protection",
abstract = "We develop a simple robust link between deep out-of-the-money American put options on a company's stock and a credit insurance contract on the company's bond. We assume that the stock price stays above a barrier B before default but drops below a lower barrier A after default, thus generating a default corridor [A,B] that the stock price can never enter. Given the presence of this default corridor, a spread between two co-terminal American put options struck within the corridor replicates a pure credit contract, paying off when and only when default occurs prior to the option expiry.",
author = "Peter Carr and Liuren Wu",
year = "2011",
month = "2",
doi = "10.1093/rfs/hhq129",
language = "English (US)",
volume = "24",
pages = "473--505",
journal = "Review of Financial Studies",
issn = "0893-9454",
publisher = "Oxford University Press",
number = "2",

}

TY - JOUR

T1 - A simple robust link between american puts and credit protection

AU - Carr, Peter

AU - Wu, Liuren

PY - 2011/2

Y1 - 2011/2

N2 - We develop a simple robust link between deep out-of-the-money American put options on a company's stock and a credit insurance contract on the company's bond. We assume that the stock price stays above a barrier B before default but drops below a lower barrier A after default, thus generating a default corridor [A,B] that the stock price can never enter. Given the presence of this default corridor, a spread between two co-terminal American put options struck within the corridor replicates a pure credit contract, paying off when and only when default occurs prior to the option expiry.

AB - We develop a simple robust link between deep out-of-the-money American put options on a company's stock and a credit insurance contract on the company's bond. We assume that the stock price stays above a barrier B before default but drops below a lower barrier A after default, thus generating a default corridor [A,B] that the stock price can never enter. Given the presence of this default corridor, a spread between two co-terminal American put options struck within the corridor replicates a pure credit contract, paying off when and only when default occurs prior to the option expiry.

UR - http://www.scopus.com/inward/record.url?scp=79251475624&partnerID=8YFLogxK

UR - http://www.scopus.com/inward/citedby.url?scp=79251475624&partnerID=8YFLogxK

U2 - 10.1093/rfs/hhq129

DO - 10.1093/rfs/hhq129

M3 - Article

VL - 24

SP - 473

EP - 505

JO - Review of Financial Studies

JF - Review of Financial Studies

SN - 0893-9454

IS - 2

ER -