Asian Options with Credit Risks: Pricing and Sensitivity Analysis

The 2008 financial crisis forced investors to be more concerned with the risk management of financial instruments, especially derivatives. The main objective of this paper is to study the effect of issuer credit risk on the pricing of options. In particular, we focus on Asian options, which are options traded in the over-the-counter market. The contribution of this study is two-fold. We first derive the approximation formula for the arithmetic Asian option subject to issuer credit risk. We then study how the contract designs and the issuers' characteristics affect the credit discount of Asian options.