Option Pricing Model Based on a Markov-modulated Diffusion with Jumps
AbstractThe paper proposes a class of financial market models which are based on inhomogeneous telegraph processes and jump diffusions with alternating volatilities. It is assumed that the jumps occur when the tendencies and volatilities are switching. We argue that such a model captures well the stock price dynamics under periodic financial cycles. The distribution of this process is described in detail. For this model we obtain the structure of the set of martingale measures. This incomplete model can be completed by adding another asset based on the same sources of randomness. Explicit closed-form formulae for prices of the standard European options are obtained for the completed market model.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 0812.0761.
Date of creation: Dec 2008
Date of revision:
Contact details of provider:
Web page: http://arxiv.org/
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
- Alessandro De Gregorio & Stefano Iacus, 2007.
"Change point estimation for the telegraph process observed at discrete times,"
UNIMI - Research Papers in Economics, Business, and Statistics
unimi-1053, Universitá degli Studi di Milano.
- Alessandro De Gregorio & Stefano M. Iacus, 2007. "Change point estimation for the telegraph process observed at discrete times," Papers 0705.0503, arXiv.org.
- X. Guo, 2001. "Information and option pricings," Quantitative Finance, Taylor & Francis Journals, vol. 1(1), pages 38-44.
- Merton, Robert C., 1975.
"Option pricing when underlying stock returns are discontinuous,"
787-75., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
- M. Montero, 2008.
"Renewal equations for option pricing,"
The European Physical Journal B - Condensed Matter and Complex Systems,
Springer, vol. 65(2), pages 295-306, September.
- Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, vol. 41(1), pages 135-55, January.
- Mazza, Christian & Rulliere, Didier, 2004. "A link between wave governed random motions and ruin processes," Insurance: Mathematics and Economics, Elsevier, vol. 35(2), pages 205-222, October.
- Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring.
- Robert J. Elliott & John van der Hoek, 1997. "An application of hidden Markov models to asset allocation problems (*)," Finance and Stochastics, Springer, vol. 1(3), pages 229-238.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Benoit Mandelbrot, 1963. "The Variation of Certain Speculative Prices," The Journal of Business, University of Chicago Press, vol. 36, pages 394.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators).
If references are entirely missing, you can add them using this form.