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Option pricing under regime switching: Integration over simplexes method

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  • Jang, Bong-Gyu
  • Tae, Hyeon-Wuk

Abstract

This paper aims to develop an alternative method for pricing European options under regime-switching market conditions by representing their values as a sum of integrations over simplexes. We calculate the integrations by using the method of Grundmann and Möller (1978). The method is applicable to the valuation of European-type options written on underlying assets whose prices follow a regime-switching mean-reverting process as well as a conventional regime-switching geometric Brownian motion. Numerical examples provide evidence that this method can be a powerful tool for practitioners in option pricing.

Suggested Citation

  • Jang, Bong-Gyu & Tae, Hyeon-Wuk, 2018. "Option pricing under regime switching: Integration over simplexes method," Finance Research Letters, Elsevier, vol. 24(C), pages 301-312.
    • Handle: RePEc:eee:finlet:v:24:y:2018:i:c:p:301-312
    DOI: 10.1016/j.frl.2017.09.021
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    Cited by:

    1. Kim, Byung-June & Jang, Bong-Gyu, 2021. "Convertible bond valuation with regime switching," Chaos, Solitons & Fractals, Elsevier, vol. 150(C).
    2. Shi, Yanlin, 2022. "A closed-form estimator for the Markov switching in mean model," Finance Research Letters, Elsevier, vol. 44(C).

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    More about this item

    Keywords

    Option pricing; Regime switch; Commodity option; Stochastic volatility; Integration over simplex;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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