A hidden Markov-modulated jump diffusion model for European option pricing

Tak Kuen Siu

doi:10.1007/978-1-4899-7442-6_8

A hidden Markov-modulated jump diffusion model for European option pricing

Tak Kuen Siu^*

^*Corresponding author for this work

Department of Applied Finance

Research output: Chapter in Book/Report/Conference proceeding › Chapter › peer-review

12 Citations (Scopus)

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	https://doi.org/10.1007/978-1-4899-7442-6_8
Publication status	Published - 2014

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10.1007/978-1-4899-7442-6_8

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A hidden Markov-modulated jump diffusion model for European option pricing. / Siu, Tak Kuen.
Hidden Markov Models in Finance : Further Developments and Applications, Volume II. ed. / Rogemar S. Mamon; Robert J. Elliott . Vol. 209 Heidelberg: Springer, Springer Nature, 2014. p. 185-209.

Research output: Chapter in Book/Report/Conference proceeding › Chapter › peer-review

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A hidden Markov-modulated jump diffusion model for European option pricing

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