Martingale representation for contingent claims with regime switching

Robert J. Elliott, Tak Kuen Siu, Hailiang Yang

Research output: Contribution to journalArticle

Abstract

We derive a martingale representation for a contingent claim under a Markov-modulated version of the Black-Scholes economy. The martingale representation for the price of the claim is established with respect to an equivalent martingale measure chosen by the Esscher transform. Under some differentiability conditions for the coefficients of the price processes, we shall identify explicitly the integrands in the martingale representation using stochastic flows. We shall introduce a zero-coupon bond to minimize the residual risk due to incomplete hedging.
Original languageEnglish
Pages (from-to)279-292
Number of pages14
JournalCommunications on stochastic analysis
Volume1
Issue number2
Publication statusPublished - 2007
Externally publishedYes

Keywords

  • Martingale Representation
  • regime-switching risk
  • Esscher transform
  • Contingent Claims
  • Stochastic Flows
  • Risk-minimization

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