Utility-based indifference pricing in regime-switching models

Robert J. Elliott*, Tak Kuen Siu

*Corresponding author for this work

Research output: Contribution to journalArticle

6 Citations (Scopus)

Abstract

In this paper, we study utility-based indifference pricing and hedging of a contingent claim in a continuous-time, Markov, regime-switching model. The market in this model is incomplete, so there is more than one price kernel. We specify the parametric form of price kernels so that both market risk and economic risk are taken into account. The pricing and hedging problem is formulated as a stochastic optimal control problem and is discussed using the dynamic programming approach. A verification theorem for the Hamilton-Jacobi-Bellman (HJB) solution to the problem is given. An issuer's price kernel is obtained from a solution of a system of linear programming problems and an optimal hedged portfolio is determined.

Original languageEnglish
Pages (from-to)6302-6313
Number of pages12
JournalNonlinear Analysis, Theory, Methods and Applications
Volume74
Issue number17
DOIs
Publication statusPublished - Dec 2011

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