SFB 303 Discussion Paper No. B-212

Author: Sandmann, K., and S. Rady

Title: The Direct Approach to Debt Option Pricing

Abstract: We review the continuous-time literature on the so-called direct approach to bond option pricing. Going back to Ball and Torous (1983), this approach models bond price processes directly (i.e. without reference to interest rates or state variable processes) and applies methods that Black and Scholes (1973) and Merton (1973) had originally developed for stock options. We describe the principal modelling problems of the direct approach and compare in detail the solutions proposed in the literature. (Completely revised version march 1995)

Keywords: Arbitrage, Debt Options, Option Pricing

JEL-Classification-Number: G13

Creation-Date: March 1995
URL: ../1995/b/b/bonnsfb212.pdf

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