TY - JOUR
T1 - Analytical Pricing Vulnerable Options with Stochastic Volatility in a Two-Factor Stochastic Interest Rate Model
AU - Jeon, Junkee
AU - Kim, Geonwoo
N1 - Publisher Copyright:
© 2025 by the authors.
PY - 2025/8
Y1 - 2025/8
N2 - This paper develops an analytical pricing formula for vulnerable options with stochastic volatility under a two-factor stochastic interest rate model. We consider the underlying asset price following the Heston stochastic volatility model, while the interest rate is modeled as the sum of two processes. Using the joint characteristic function approach and measure change techniques, we derive an explicit pricing formula for a vulnerable European option. We also conduct numerical experiments to examine the effects of various model parameters on option values. This study provides a more realistic framework for pricing OTC derivatives by incorporating credit risk, stochastic volatility, and stochastic interest rates simultaneously.
AB - This paper develops an analytical pricing formula for vulnerable options with stochastic volatility under a two-factor stochastic interest rate model. We consider the underlying asset price following the Heston stochastic volatility model, while the interest rate is modeled as the sum of two processes. Using the joint characteristic function approach and measure change techniques, we derive an explicit pricing formula for a vulnerable European option. We also conduct numerical experiments to examine the effects of various model parameters on option values. This study provides a more realistic framework for pricing OTC derivatives by incorporating credit risk, stochastic volatility, and stochastic interest rates simultaneously.
KW - characteristic function
KW - stochastic interest rate
KW - stochastic volatility
KW - vulnerable option
UR - https://www.scopus.com/pages/publications/105013301640
U2 - 10.3390/math13152515
DO - 10.3390/math13152515
M3 - Article
AN - SCOPUS:105013301640
SN - 2227-7390
VL - 13
JO - Mathematics
JF - Mathematics
IS - 15
M1 - 2515
ER -