Pricing European options under stochastic looping contagion risk model (Q6179935)

The authors introduce the looping contagion model under physical measure, and transform it into one under risk-neutral measure for option pricing. Then they derive the semi-explicit pricing formula for European call options, and establish the pricing PDEs associated with the boundary conditions. Unconditionally stable numerical methods based on the Fourier analysis technique are used to solve the pricing PDEs. The option prices are also computed by using Monte Carlo simulations and semi-explicit pricing formula. Some numerical examples which confirm the convergence of the numerical methods, and some economic explanations by means of sensitivity analysis are finally given.