Pricing exotic options under a high-order Markovian regime-switching model

Wai Kai Ching, Tak Kuen Siu, Li Min Li

Research output: Contribution to journalArticle

17 Citations (Scopus)
21 Downloads (Pure)

Abstract

We consider the pricing of exotic options when the price dynamics of the underlying risky asset are governed by a discrete-time Markovian regime-switching process driven by an observable, high-order Markov model (HOMM). We assume that the market interest rate, the drift, and the volatility of the underlying risky asset's return switch over time according to the states of the HOMM, which are interpreted as the states of an economy. We will then employ the well-known tool in actuarial science, namely, the Esscher transform to determine an equivalent martingale measure for option valuation. Moreover, we will also investigate the impact of the high-order effect of the states of the economy on the prices of some path-dependent exotic options, such as Asian options, lookback options, and barrier options.

Original languageEnglish
Article number18014
Pages (from-to)1-15
Number of pages15
JournalJournal of Applied Mathematics and Decision Sciences
Volume2007
DOIs
Publication statusPublished - 2007

Bibliographical note

Copyright the Author(s) 2007. Version archived for private and non-commercial use with the permission of the author/s and according to publisher conditions. For further rights please contact the publisher.

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