In this paper I examine how the spread arising from the risk of default and issuers use of call option can be priced using the binomial model and the models proposed by Black Scholes and Merton. The paper offers a guide to how the binomial model can be calibrated to that exact function, and show how this is done in the current state of negative interest rates. The binomial model is calibrated using the Ho-Lee model. A model that allows for negative interest rates. I also show how implied volatility can be extracted using the functions in the Ho-Lee model. Other volatility is calculated using historical volatility and EWMA. Along the course we test if our material follows a normal distribution. My conclusion is, that using Black Scholes and binomial lattices, risk premiums can easily be identified given the correct information is available. My paper can also find its use as a guide to the mistakes and flaws that can arise while working with the before mentioned models.
|Educations||Graduate Diploma in Finance, (Diploma Programme) Final Thesis|
|Number of pages||77|