On the Distribution of First Exit Time for Brownian Motion with Double Linear Time-Dependent Barriers

This paper focuses on the first exit time for a Brownian motion with a double linear time-dependent barrier specified by , , ( , , ). We are concerned in this paper with the distribution of the Brownian motion hitting the upper barrier before hitting the lower linear barrier. The main method we applied here is the Girsanov transform formula. As a result, we expressed the density of such exit time in terms of a finite series. This result principally provides us an analytical expression for the distribution of the aforementioned exit time and an easy way to compute the distribution of first exit time numerically. 1. Introduction In financial investment affairs, investors are exposed to credit risk, due to the possibility that one or more counterparts in a financial agreement will default (cf [1]). The default time is sometimes modeled as the first exit time of a credit index process below a barrier. Original credit models can be found in Merton [2] and Black and Cox [3], where the return of market value is supposed to be a drifted Brownian motion. When the market value of assets goes below some level, determined in terms of the company’s liabilities, then the company is apt to default on its obligations. The first passage time density is required in order to obtain the expected discounted cash flows (say for a loan to the considered company). They define the time of default as the first time the ratio of the value of a firm and the value of its debt falls below a constant level, and they model debt as a zero-coupon bond and the value of the firm as a geometric Brownian motion. In this case, the default time has the distribution of the first-passage time of a Brownian motion (with constant drift) below a certain barrier. Hull and White [4] model the default time as the first time a Brownian motion hits a given time-dependent barrier. They show that this model gives the correct market credit default swap and bond prices if the time-dependent barrier is chosen so that the first passage time of the Brownian motion has a certain distribution derived from those prices. Given a distribution for the default time, it is usually impossible to find a closed-form expression for the corresponding time-dependent barrier, in derivatives pricing, such as pricing barrier options or lookback options, which involve crossing certain levels (cf Chadam et al. [5], Merton [6], and Metwally and Atiya [7]), or pricing American options [8], which entail evaluating the first passage time density for a time varying boundary. Such applications are typically applied to large