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Option Model (option + model)

Distribution by Scientific Domains

Business, Economics, Finance and Accounting	100%

Selected Abstracts

Product Development and Market Expansion: A Real Options Model

FINANCIAL MANAGEMENT, Issue 1 2007
Andrea Gamba
We create a model that values complementary and substitute products with potentially correlated revenues, which must be developed sequentially. The model also incorporates the effects of changing market conditions. We find that the value of a combined project increases in correlation, but the probability of investing in the initial product is a decreasing function of correlation. These results are reversed if the products are substitutes. Regardless of the correlation level, higher levels of substitutability reduce the value of the combined projects and increase the probability of investing. Despite greater uncertainty during the phase of limited competition, the firm is more likely to invest early than to postpone investment. [source]

Mortgage Terminations, Heterogeneity and the Exercise of Mortgage Options

ECONOMETRICA, Issue 2 2000
Yongheng Deng
As applied to the behavior of homeowners with mortgages, option theory predicts that mortgage prepayment or default will be exercised if the call or put option is ,in the money' by some specific amount. Our analysis: tests the extent to which the option approach can explain default and prepayment behavior; evaluates the practical importance of modeling both options simultaneously; and models the unobserved heterogeneity of borrowers in the home mortgage market. The paper presents a unified model of the competing risks of mortgage termination by prepayment and default, considering the two hazards as dependent competing risks that are estimated jointly. It also accounts for the unobserved heterogeneity among borrowers, and estimates the unobserved heterogeneity simultaneously with the parameters and baseline hazards associated with prepayment and default functions. Our results show that the option model, in its most straightforward version, does a good job of explaining default and prepayment, but it is not enough by itself. The simultaneity of the options is very important empirically in explaining behavior. The results also show that there exists significant heterogeneity among mortgage borrowers. Ignoring this heterogeneity results in serious errors in estimating the prepayment behavior of homeowners. [source]

Determinants of Multifamily Mortgage Default

REAL ESTATE ECONOMICS, Issue 3 2002
Wayne R. Archer
Option,based models of mortgage default posit that the central measure of default risk is the loan,to,value (LTV) ratio. We argue, however, that an unrecognized problem with extending the basic option model to existing multifamily and commercial mortgages is that key variables in the option model are endogenous to the loan origination and property sale process. This endogeneity implies, among other things, that no empirical relationship may be observed between default and LTV. Since lenders may require lower LTVs in order to mitigate risk, mortgages with low and moderate LTVs may be as likely to default as those with high LTVs. Mindful of this risk endogeneity and its empirical implications, we examine the default experience of 495 fixed,rate multifamily mortgage loans securitized by the Resolution Trust Corporation (RTC) and the Federal Deposit Insurance Corporation (FDIC) during the period 1991,1996. The extensive nature of the data supports multivariate analysis of default incidence in a number of respects not possible in previous studies. Consistent with our expectations, we find that LTV evidences no relationship to default incidence, while the strongest predictors of default are property characteristics, including three,digit ZIP code location and initial cash flow as reflected in the debt coverage ratio. The latter results are particularly interesting in that they dominated the influence of postorigination changes in the local economy. [source]

Are credit spreads too low or too high?

THE JOURNAL OF FUTURES MARKETS, Issue 12 2009
A hybrid barrier option approach for financial distress
Based on the works of Brockman, P. and Turtle, H. J. (2003) and Giesecke, K. (2004), we propose in this study a hybrid barrier option model to explain observed credit spreads. It is free of problems with the structural model, which underprescribed credit spreads for investment grade corporate bonds and overprescribed the high-yield issues. Unlike the standard barrier option approach, our hybrid model does not imply, for high-yield issues with firms under financial stress, a reduction of credit spreads while firm value actually falls. Our empirical analysis supports that when credit spreads are quoted abnormally higher or rising faster than expected, unexpected changes tend to persist. Otherwise a significant and prompt reversion to long-term equilibrium takes place. This asymmetric pricing phenomenon is validated with a method introduced by Enders, W. and Granger, C. W. J. (1998) and Enders, W. and Siklos, P. L. (2001). The pricing asymmetry could not have been produced by a structural model employing only standard option. But it is consistent with a hybrid barrier option model. Our model characterizes the valuation of debt under financial stress and the asymmetric price pattern better than both the classical structural and the standard barrier option approaches. It can be extended to the study of individual CDS for its better liquidity than individual corporate bonds. This study provides helpful implications especially for the medium and high-yield issues in pricing as well as portfolio diversification. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:1161,1189, 2009 [source]

Optimal No-Arbitrage Bounds on S&P 500 Index Options and the Volatility Smile

THE JOURNAL OF FUTURES MARKETS, Issue 12 2001
Patrick J. Dennis
This article shows that the volatility smile is not necessarily inconsistent with the Black,Scholes analysis. Specifically, when transaction costs are present, the absence of arbitrage opportunities does not dictate that there exists a unique price for an option. Rather, there exists a range of prices within which the option's price may fall and still be consistent with the Black,Scholes arbitrage pricing argument. This article uses a linear program (LP) cast in a binomial framework to determine the smallest possible range of prices for Standard & Poor's 500 Index options that are consistent with no arbitrage in the presence of transaction costs. The LP method employs dynamic trading in the underlying and risk-free assets as well as fixed positions in other options that trade on the same underlying security. One-way transaction-cost levels on the index, inclusive of the bid,ask spread, would have to be below six basis points for deviations from Black,Scholes pricing to present an arbitrage opportunity. Monte Carlo simulations are employed to assess the hedging error induced with a 12-period binomial model to approximate a continuous-time geometric Brownian motion. Once the risk caused by the hedging error is accounted for, transaction costs have to be well below three basis points for the arbitrage opportunity to be profitable two times out of five. This analysis indicates that market prices that deviate from those given by a constant-volatility option model, such as the Black,Scholes model, can be consistent with the absence of arbitrage in the presence of transaction costs. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:1151,1179, 2001 [source]