Counterparty credit risk and derivatives pricing

Gang Li, Chu Zhang

Research output: Journal article publicationJournal articleAcademic researchpeer-review

Abstract

We derive a model with qualitative implications for options pricing under counterparty credit risk and provide empirical evidence using the data from the Hong Kong derivatives market during 2005–2014. We find that the log-price difference between a derivative warrant with counterparty credit risk and an otherwise identical option without counterparty credit risk is significantly and negatively associated with the credit default swap spread on the warrant issuer. We also find that the prices of out-of-the-money put warrants are more sensitive to credit risk than those of other warrants. Our results show counterparty credit risk matters for derivative pricing.
Original languageEnglish
Pages (from-to)647-668
Number of pages22
JournalJournal of Financial Economics
Volume134
Issue number3
Publication statusPublished - Dec 2019

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