Unformatted text preview: (1976) introduce the default barrier, H . Whenever the ﬁrm value hits the downside default barrier, a default event is triggered, and debt holders will own the ﬁrm upon default. Under the Black-Cox model, the market value of equity becomes a down-and-out (DOC) call option on the ﬁrm with strike price D and barrier level H . Answer the following questions based on the Black-Cox model. (a) The debtholders’ position can be fully replicated by a long position of a default-free bond, a short position of a put option and a long position of a barrier option. What is that barrier option? (b) Other things being ﬁxed, show that the DOC option price in-creases from 0 to the standard call option price when the barrier level H decreases from V t to 0. (Hint: You may use no-arbitrage arguments.) (c) Show that, if V t = S t + D , then H > D . What is the problem with this consequence? 1...
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This note was uploaded on 04/22/2011 for the course RMSC 4007 taught by Professor Wonghoiying during the Spring '11 term at CUHK.
- Spring '11