On pricing and hedging options in regime-switching models with feedback effect
AbstractWe study the pricing and hedging of European-style derivative securities in a Markov, regime-switching, model with a feedback effect depending on the economic condition. We adopt a pricing kernel which prices both financial and economic risks explicitly in a dynamically incomplete market and we provide an equilibrium analysis. A martingale representation for a European-style index option's price is established based on the price kernel. The martingale representation is then used to construct the local risk-minimizing strategy explicitly and to characterize the corresponding pricing measure.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Economic Dynamics and Control.
Volume (Year): 35 (2011)
Issue (Month): 5 (May)
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Web page: http://www.elsevier.com/locate/jedc
Pricing and hedging Regime-switching Feedback effect Product price kernel Local risk-minimization;
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