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Pricing exotic options in a regime switching economy: a Fourier transform method

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  • Peter Hieber

    (University of Ulm)

Abstract

This article considers the valuation of digital, barrier, and lookback options in a Markovian, regime-switching, Black–Scholes model. In Fourier space, integral representations for the option prices are derived via the theory on matrix Wiener–Hopf factorizations. Our main focus is on the 2-state case where the matrix Wiener–Hopf factorization is available analytically. A comparison to several numerical alternatives (analytical approximations, the Brownian bridge algorithm and a finite element scheme) demonstrates that the pricing formulas are easy to implement and lead to accurate price estimates.

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  • Peter Hieber, 2018. "Pricing exotic options in a regime switching economy: a Fourier transform method," Review of Derivatives Research, Springer, vol. 21(2), pages 231-252, July.
    • Handle: RePEc:kap:revdev:v:21:y:2018:i:2:d:10.1007_s11147-017-9139-1
    DOI: 10.1007/s11147-017-9139-1
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    References listed on IDEAS

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