Pricing Basket Spread Options With Default Risk Under GARCH-Jump Models

Abstract

In this article, we consider basket spread options with default risk in a pricing model, where GARCH-jump processes are employed to describe the dynamics of all the underlying assets, and default risk is incorporated in a reduced form model. After successfully deriving the approximate pricing formula, we utilize the average cumulative default rates provided by Moody's spanning from 1970 to 2015 to estimate the parameters in the default intensity. Finally, we illustrate the impact of jump risk and default risk on basket spread options after checking the accuracy and efficiency of the approximate prices via Monte Carlo simulation methods.