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This paper develops a valuation model of vulnerable American put options incorporating the correlated credit risk. The dynamics of the underlying asset, the counterparty assets and corporate liabilities are modeled as jump-diffusion processes. The sudden shocks on two related assets and corporate liabilities are divided into systematic component affecting the prices of all assets and idiosyncratic component for each asset. By employing the two-point Geske-Johnson method, we propose an approximate analytical pricing formula for vulnerable American put options. Finally the numerical analysis illustrates the impacts of jump risk and stochastic corporate liabilities on the option prices.

Pricing vulnerable American put options under jump-diffusion processes when corporate liabilities are random