Valuation of European option with correlated credit risk and stochastic interest

In this paper, we derive an explicit pricing formula for vulnerable call options where the credit risk is handled in a hybrid model. We describe the process of default via a doubly stochastic Poisson process, and assume that the intensity process λ of the Poisson process follows a mean-reverting process. Moreover, the default intensity process λ mutually correlates with the underlying asset and the value of the firm. By applying a changing measure, closed-form solutions of the pricing formula are derived within a general Gaussian interest rate framework.