Review of Financial Studies Vol. 24 No. 2 2011
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.]
- Volume
- 24
- Issue
- 2
- Pages
- 473-505
- Sources
- bibtex:phds-export.bib