Pricing vulnerable options under a Markov-modulated jump-diffusion model with fire sales

Qing-Qing Yang*, Wai-Ki Ching, Wanhua He, Tak-Kuen Siu

*Corresponding author for this work

Research output: Contribution to journalArticle

Abstract

In this paper, we consider the valuation of vulnerable options under a Markov-modulated jump-diffusion model, where the option writer's asset value is subject to price pressure from other financial institutions due to distressed selling. A change of numeraire technique, proposed by Geman et al. [14], is employed to obtain a semi-analytical pricing formula for an vulnerable European option in the presence of regime switching effect. The method is numerically implemented using the multinomial approach in Costabile et al. [6]. We study the impacts of distressed selling and regime switching on the European option prices via numerical experiments.

Original languageEnglish
Pages (from-to)293-318
Number of pages26
JournalJournal of Industrial and Management Optimization
Volume15
Issue number1
DOIs
Publication statusPublished - Jan 2019

Keywords

  • Vulnerable option
  • regime-switching
  • change of numéraire
  • distressed selling
  • multinomial approach

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