An Application of New Barrier Options (Edokko Options) for Pricing Bonds with Credit Risk

Abstract

In order to price bonds with credit risk, we can consider structural models. Basically, default occurs if the value of the firm hits some pre-specified barrier in these models. We extend traditional structural models to put the additional default condition such that the value of the firm remains under some pre-specified level for a long period of time until the maturity after the first time hitting this level. A new framework of barrier options (Edokho Options) allows us to extend default condition. In our approach, the way to describe default time can be applied more precisely to the real world.