Valuation of the prepayment option of a perpetual corporate loan
Date
2013Link to item file
https://hal.archives-ouvertes.fr/hal-00653041Dewey
Economie financièreSujet
CIR process; prepayment option; Snell envelope; option pricing; perpetual option; American option; mortgage option; switching regimes; loan prepayment; Markov modulated dynamics; liquidity regimeJEL code
E4Journal issue
Abstract and Applied AnalysisVolume
2013Publication date
2013Article pages
ID 960789Publisher
Mancorp PubCollections
Metadata
Show full item recordAuthor
Papin, Timothée
Turinici, Gabriel
Type
Abstract (EN)
We investigate in this paper a perpetual prepayment option related to a corporate loan. The default intensity of the firm is supposed to follow a CIR process. Two frameworks are discussed: first a constant interest rate and a secondly a multi-regime framework where the interest rate is augmented by a liquidity factor dependent on the regime. The prepayment option needs specific attention as the payoff itself is an implicit function of the parameters of the problem and of the dynamics. We establish in the unique regime case analytic formulas for the payoff of the option; in both cases we give a verification result that allows to compute the price of the option. Numerical results that implement the findings are also presented and are completely consistent with the theory; it is seen that when liquidity parameters are very different (i.e., when a liquidity crisis occur) in the high liquidity cost regime the exercise domain may entirely disappear meaning that it is not optimal for the borrower to prepay during such a liquidity crisis. The method allows to quantify and interpret these findings.Related items
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