Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/337284 
Year of Publication: 
2024
Citation: 
[Journal:] Journal of Derivatives and Quantitative Studies: Seonmul yeon'gu (JDQS) [ISSN:] 2713-6647 [Volume:] 32 [Issue:] 4 [Year:] 2024 [Pages:] 286-322
Publisher: 
Emerald, Leeds
Abstract: 
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.
Subjects: 
Connection of debt and equity
Credit risk management
Distance to default
Equity derivatives
Partial hedging strategies
SCR reduction
Persistent Identifier of the first edition: 
Creative Commons License: 
cc-by Logo
Document Type: 
Article

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