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Option Pricing in a Regime Switching Stochastic Volatility Model

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  • Arunangshu Biswas
  • Anindya Goswami
  • Ludger Overbeck

Abstract

In the classical model of stock prices which is assumed to be Geometric Brownian motion, the drift and the volatility of the prices are held constant. However, in reality, the volatility does vary. In quantitative finance, the Heston model has been successfully used where the volatility is expressed as a stochastic differential equation. In addition, we consider a regime switching model where the stock volatility dynamics depends on an underlying process which is possibly a non-Markov pure jump process. Under this model assumption, we find the locally risk minimizing pricing of European type vanilla options. The price function is shown to satisfy a Heston type PDE.

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  • Arunangshu Biswas & Anindya Goswami & Ludger Overbeck, 2017. "Option Pricing in a Regime Switching Stochastic Volatility Model," Papers 1707.01237, arXiv.org, revised Jan 2018.
    • Handle: RePEc:arx:papers:1707.01237
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    Cited by:

    1. Liu, Yue & Sun, Huaping & Zhang, Jijian & Taghizadeh-Hesary, Farhad, 2020. "Detection of volatility regime-switching for crude oil price modeling and forecasting," Resources Policy, Elsevier, vol. 69(C).
    2. Anindya Goswami & Omkar Manjarekar & Anjana R, 2018. "Option Pricing in a Regime Switching Jump Diffusion Model," Papers 1811.11379, arXiv.org, revised Oct 2019.
    3. H. T. Shehzad & M. A. Anwar & M. Razzaq, 2023. "A Comparative Predicting Stock Prices using Heston and Geometric Brownian Motion Models," Papers 2302.07796, arXiv.org.
    4. Liu, Yue & Tian, Lixin & Sun, Huaping & Zhang, Xiling & Kong, Chuimin, 2022. "Option pricing of carbon asset and its application in digital decision-making of carbon asset," Applied Energy, Elsevier, vol. 310(C).

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