Abstract
The valuation of a European-style contingent claim is discussed in a hidden Markov regime-switching jump-diffusion market, where the evolution of a hidden economic state process over time is described by a continuous-time, finite-state, hidden Markov chain. A two-stage procedure is used to discuss the option valuation problem. Firstly filtering theory is employed to transform the original market with hidden quantities into a filtered market with complete observations. Then a generalized version of the Esscher transform based on a Dolé-Dade stochastic exponential is employed to select a pricing kernel in the filtered market. A partialdifferential- integral equation for the price of a European-style option is presented.
| Original language | English |
|---|---|
| Title of host publication | Hidden Markov Models in Finance |
| Subtitle of host publication | Further Developments and Applications, Volume II |
| Editors | Rogemar S. Mamon, Robert J. Elliott |
| Place of Publication | Heidelberg |
| Publisher | Springer, Springer Nature |
| Pages | 185-209 |
| Number of pages | 25 |
| Volume | 209 |
| ISBN (Electronic) | 9781489974426 |
| ISBN (Print) | 9781489974419 |
| DOIs | |
| Publication status | Published - 2014 |