The Effect of Credit Risks on Asian Options Pricing

Due to the fact that the over-the-counter (OTC) market has no organized exchange, the options traded in the OTC market are more likely to be exposed to the credit risk. Asian option is one of them. In this paper we first discuss the pricing of arithmetic Asian options and the Black-Scholes options model subject to the credit risk. We then combine the two models to derive an explicit approximation formula for pricing an arithmetic Asian option subject to the credit risk. The numerical analysis reveals that our formula can get accurate result. In addition, the pricing formulae existed in the literature can cause serious pricing errors when there is a possibility of default in reality