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Review of Quantitative Finance and Accounting

, Volume 52, Issue 4, pp 1065–1084 | Cite as

Debt rollover-induced local volatility model

  • Oleg SokolinskiyEmail author
Original Research
  • 46 Downloads

Abstract

This paper introduces a structural scenario-based model with debt rollover risk and a higher-fidelity treatment of the bankruptcy procedure. The emerging stock price process is a generalized Brownian motion with state-dependent local volatility, and the resultant implied volatility smile is due exclusively to structural features (debt rollover and credit risks). Therefore, the model reinforces structural foundations of local volatility option pricing models. The paper advocates a joint modeling and calibration framework for multiple classes of derivatives on the firm’s asset value. In particular, an empirical application to Solar City equity and stock option valuation demonstrates the versatility and efficiency gains of the suggested model.

Keywords

Option pricing Rollover risk Credit risk Local volatility Volatility smile Reorganization 

JEL Classification

G13 

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Copyright information

© Springer Science+Business Media, LLC, part of Springer Nature 2018

Authors and Affiliations

  1. 1.Rutgers Business School - Newark and New BrunswickPiscatawayUSA

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