Partial hedging in credit markets with structured derivatives: a quantitative approach using put options
This study develops a novel method for mitigating credit risk through the use of structured derivatives, focusing in particular on the use of European put options as a strategic hedging tool. Inspired by the work of Merton (1974), our approach introduces the concept of default triggered by the stock...
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| Format: | Article |
| Language: | English |
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Emerald Publishing
2024-11-01
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| Series: | Seonmul yeongu |
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| Online Access: | https://www.emerald.com/insight/content/doi/10.1108/JDQS-06-2024-0019/full/pdf |
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| author | Constantin Siggelkow |
| author_facet | Constantin Siggelkow |
| author_sort | Constantin Siggelkow |
| collection | DOAJ |
| description | This study develops a novel method for mitigating credit risk through the use of structured derivatives, focusing in particular on the use of European put options as a strategic hedging tool. Inspired by the work of Merton (1974), our approach introduces the concept of default triggered by the stock price ST breaching a predefined barrier B. By establishing a distributional equivalence between an existing default model and P(ST<B) for a given time T, we demonstrate the potential for reducing the necessary capital allocation for a projected loss X(T) by partially hedging with a European put option. We formulate and solve an optimization problem w.r.t. a specific risk measure to determine the optimal strike price for the option, and our numerical analysis confirms a reduction in the Solvency Capital Requirement (SCR) in markets with and without jumps. Our findings provide (insurance) companies with a pragmatic approach to mitigating losses while maintaining their current risk management framework. |
| format | Article |
| id | doaj-art-e502b8030c7b43338c602f5cd6f160b6 |
| institution | Kabale University |
| issn | 1229-988X 2713-6647 |
| language | English |
| publishDate | 2024-11-01 |
| publisher | Emerald Publishing |
| record_format | Article |
| series | Seonmul yeongu |
| spelling | doaj-art-e502b8030c7b43338c602f5cd6f160b62024-11-20T05:40:54ZengEmerald PublishingSeonmul yeongu1229-988X2713-66472024-11-0132428632210.1108/JDQS-06-2024-0019Partial hedging in credit markets with structured derivatives: a quantitative approach using put optionsConstantin Siggelkow0Chair of Mathematical Finance, TUM, Munich, GermanyThis study develops a novel method for mitigating credit risk through the use of structured derivatives, focusing in particular on the use of European put options as a strategic hedging tool. Inspired by the work of Merton (1974), our approach introduces the concept of default triggered by the stock price ST breaching a predefined barrier B. By establishing a distributional equivalence between an existing default model and P(ST<B) for a given time T, we demonstrate the potential for reducing the necessary capital allocation for a projected loss X(T) by partially hedging with a European put option. We formulate and solve an optimization problem w.r.t. a specific risk measure to determine the optimal strike price for the option, and our numerical analysis confirms a reduction in the Solvency Capital Requirement (SCR) in markets with and without jumps. Our findings provide (insurance) companies with a pragmatic approach to mitigating losses while maintaining their current risk management framework.https://www.emerald.com/insight/content/doi/10.1108/JDQS-06-2024-0019/full/pdfCredit risk managementEquity derivativesPartial hedging strategiesSCR reductionDistance to defaultConnection of debt and equity |
| spellingShingle | Constantin Siggelkow Partial hedging in credit markets with structured derivatives: a quantitative approach using put options Seonmul yeongu Credit risk management Equity derivatives Partial hedging strategies SCR reduction Distance to default Connection of debt and equity |
| title | Partial hedging in credit markets with structured derivatives: a quantitative approach using put options |
| title_full | Partial hedging in credit markets with structured derivatives: a quantitative approach using put options |
| title_fullStr | Partial hedging in credit markets with structured derivatives: a quantitative approach using put options |
| title_full_unstemmed | Partial hedging in credit markets with structured derivatives: a quantitative approach using put options |
| title_short | Partial hedging in credit markets with structured derivatives: a quantitative approach using put options |
| title_sort | partial hedging in credit markets with structured derivatives a quantitative approach using put options |
| topic | Credit risk management Equity derivatives Partial hedging strategies SCR reduction Distance to default Connection of debt and equity |
| url | https://www.emerald.com/insight/content/doi/10.1108/JDQS-06-2024-0019/full/pdf |
| work_keys_str_mv | AT constantinsiggelkow partialhedgingincreditmarketswithstructuredderivativesaquantitativeapproachusingputoptions |