Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 314: A Note on Contingent Claims Pricing with Non-Traded Assets

Jan Ericsson () and Joel Reneby ()
Additional contact information
Jan Ericsson: McGill University, Postal: Faculty of Management, 1001 Sherbrooke Street West, Montreal PQ, Canada H3A 1G5
Joel Reneby: Dept. of Finance, Stockholm School of Economics, Postal: P.O. Box 6501, SE-113 83 Stockholm, Sweden

Abstract: One of the main objections to applying contingent claims analysis outside the area of derivatives pricing, such as to the pricing of corporate (or sovereign) debt, has been that it is not possible to trade in the relevant state variable, e.g. the assets of a firm. Consequently, replicating portfolios can not be formed and preference free pricing does not result.

The aim of this paper is to show that assuming traded assets, as is routinely done, is inconsistent with the presence of stocks and bonds. It is also unnecessary. We argue that a superior alternative to obtain a complete markets setting, is to assume that at least one of the firm's securities, e.g. equity, is traded.

Keywords: corporate bonds; real options; contingent claims; traded assets; underlying assets.

JEL-codes: G13

8 pages, First version: March 29, 1999. Revised: July 1, 2002. Earlier revisions: February 1, 2002, February 7, 2002, July 1, 2002.

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