Article 4, Volume 2 Issue 2:

Firm valuation and default probability through exotic (barrier) options

Author

Gaston Milanesi – (Universidad Nacional del Sur)

Gabriela Pesce – (Universidad Nacional del Sur)

Emilio El Alabi – (Universidad Nacional del Sur)

Received April 11, 2016; accepted May 23, 2016.

Abstract

Real option theory allows using financial option models to value investments and firms. Traditional models present a substantial problem to positively correlate underlying asset volatility with firm value. Therefore, an alternative approach is used based on a particular type of exotic option, the barrier one. This dynamic model helps estimating default probability incorporating the negative impact that excessive risk has on firm value. The article presents a hypothetical example illustrating similarities and differences between the proposed model and the traditional version. Finally, this model is applied on two of the leading companies in the Argentinean capital market which are characterized by different levels of leverage demonstrating the robustness of the results. The predicted default probability increases with the rise in assets volatility and the time horizon of debt maturity.

La teoría de la opción real permite utilizar modelos de opciones financieras para valorar las inversiones y las empresas. Los modelos tradicionales presentan un problema sustancial para correlacionar positivamente la volatilidad de los activos subyacentes con el valor de la empresa. Por lo tanto, se utiliza un enfoque alternativo basado en un tipo particular de opción exótica, la barrera. Este modelo dinámico ayuda a estimar la probabilidad de incumplimiento incorporando el impacto negativo que el riesgo excesivo tiene en el valor de la empresa. El artículo presenta un ejemplo hipotético que ilustra similitudes y diferencias entre el modelo propuesto y la versión tradicional. Finalmente, este modelo se aplica a dos de las empresas líderes en el mercado de capitales argentino que se caracterizan por diferentes niveles de apalancamiento que demuestran la solidez de los resultados. La probabilidad de incumplimiento prevista aumenta con el aumento de la volatilidad de los activos y el horizonte temporal del vencimiento de la deuda.

Citation

Milanesi, G. S., Pesce, G., & El Alabi, E. (2016). Firm valuation and default probability through exotic (barrier) options. European Accounting and Management Review2(2), 56-76.

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