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State-dependent jump risks for American gold futures option pricing

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  • Lian, Yu-Min
  • Liao, Szu-Lang
  • Chen, Jun-Home

Abstract

In this study, we investigate the valuation of American-style options when the underlying gold futures price follows a pure diffusion structure with state-dependent jump dynamics. Under such dynamics, the jump events are described as a compound Poisson process with a log-normal jump amplitude, and the regime-switching arrival intensity is captured by a hidden Markov chain whose states represent the economic states. Considering the different jump risk assumptions, we use the Merton measure and Esscher transform to derive risk-neutral gold futures price dynamics under an incomplete market setting. To achieve a desired accuracy level, the least-squares Monte Carlo method is used to approximate the values of American gold futures options. Our empirical and numerical results based on actual market data are provided to illustrate the importance of incorporating state-dependent jump risks when pricing American put options on gold futures.

Suggested Citation

  • Lian, Yu-Min & Liao, Szu-Lang & Chen, Jun-Home, 2015. "State-dependent jump risks for American gold futures option pricing," The North American Journal of Economics and Finance, Elsevier, vol. 33(C), pages 115-133.
    • Handle: RePEc:eee:ecofin:v:33:y:2015:i:c:p:115-133
    DOI: 10.1016/j.najef.2015.04.001
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    More about this item

    Keywords

    State-dependent jump risk; American gold futures option; Merton measure; Esscher transform; Least-squares Monte Carlo method;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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