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Closed-form solutions to stochastic process switching problems

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  • François, Pascal
  • Morellec, Erwan
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    Abstract

    This paper studies the price of an asset depending on both a fundamental and possible interventions of an authority. Using the martingale approach in continuous time, we provide closed-form solutions to switching problems involving irreversible, state dependent and intramarginal switch policies. The martingale approach provides additional information regarding the switching policy, namely the average time before authority intervention, the conditional probability of intervention, or the total time of intervention. Applications in international and financial economics include exchange rates modelling, corporate claims valuation and capital budgeting decisions.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Mathematical Economics.

    Volume (Year): 44 (2008)
    Issue (Month): 11 (December)
    Pages: 1072-1083

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    Handle: RePEc:eee:mateco:v:44:y:2008:i:11:p:1072-1083

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    Web page: http://www.elsevier.com/locate/jmateco

    Related research

    Keywords: Stochastic process switching Irreversible switch State-dependent switch Infra-marginal switch;

    References

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