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Pricing Vulnerable Options with Market Prices of Common Jump Risks under Regime-Switching Models

Author

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  • Miao Han
  • Xuefeng Song
  • Huawei Niu
  • Shengwu Zhou

Abstract

This paper investigates the valuation of vulnerable European options considering the market prices of common systematic jump risks under regime-switching jump-diffusion models. The way of regime-switching Esscher transform is adopted to identify an equivalent martingale measure for pricing vulnerable European options. Explicit analytical pricing formulae for vulnerable European options are derived by risk-neutral pricing theory. For comparison, the other two cases are also considered separately. The first case considers all jump risks as unsystematic risks while the second one assumes all jumps risks to be systematic risks. Numerical examples for the valuation of vulnerable European options are provided to illustrate our results and indicate the influence of the market prices of jump risks on the valuation of vulnerable European options.

Suggested Citation

  • Miao Han & Xuefeng Song & Huawei Niu & Shengwu Zhou, 2018. "Pricing Vulnerable Options with Market Prices of Common Jump Risks under Regime-Switching Models," Discrete Dynamics in Nature and Society, Hindawi, vol. 2018, pages 1-15, January.
    • Handle: RePEc:hin:jnddns:8545841
    DOI: 10.1155/2018/8545841
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    Cited by:

    1. Xiangdong Liu & Zanbin Zhang, 2023. "Pricing European Vulnerable Options with Jumps and Stochastic Default Obstacles Barrier under Regime Switching," Mathematics, MDPI, vol. 11(19), pages 1-18, October.
    2. Xie, Yurong & Deng, Guohe, 2022. "Vulnerable European option pricing in a Markov regime-switching Heston model with stochastic interest rate," Chaos, Solitons & Fractals, Elsevier, vol. 156(C).
    3. Focardi, Sergio M. & Fabozzi, Frank J. & Mazza, Davide, 2019. "Modeling local trends with regime shifting models with time-varying probabilities," International Review of Financial Analysis, Elsevier, vol. 66(C).

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