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On the Price of Risk Under a Regime Switching CGMY Process

Author

Listed:
  • Pious Asiimwe

    (University of Dar es Salaam)

  • Charles Wilson Mahera

    (African Institute of Mathematical Sciences)

  • Olivier Menoukeu-Pamen

    (University of Liverpool)

Abstract

In this paper, we study option pricing under a regime-switching exponential Lévy model. Assuming that the coefficients are time-dependent and modulated by a finite state Markov chain, we generalise the work in Momeya and Morales (Method Comput Appl Probab, 2014, doi: 10.1007/s11009-014-9399-2 ), and Siu and Yang (Acta Mathe Appl Sin 2:369–388, 2009), that is, we use a pricing method based on the Esscher transform conditional on the information available on the Markov chain. We also carry out numerical analysis, to show the impact of the risk induced by the underlying Markov chain on the price of the option.

Suggested Citation

  • Pious Asiimwe & Charles Wilson Mahera & Olivier Menoukeu-Pamen, 2016. "On the Price of Risk Under a Regime Switching CGMY Process," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 23(4), pages 305-335, December.
    • Handle: RePEc:kap:apfinm:v:23:y:2016:i:4:d:10.1007_s10690-016-9219-5
    DOI: 10.1007/s10690-016-9219-5
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    References listed on IDEAS

    as
    1. Robert J. Elliott & Leunglung Chan & Tak Kuen Siu, 2005. "Option pricing and Esscher transform under regime switching," Annals of Finance, Springer, vol. 1(4), pages 423-432, October.
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    5. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters, in: Sudipto Bhattacharya & George M Constantinides (ed.), Theory Of Valuation, chapter 8, pages 229-288, World Scientific Publishing Co. Pte. Ltd..
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    9. Robert J. Elliott & Carlton-James U. Osakwe, 2006. "Option Pricing for Pure Jump Processes with Markov Switching Compensators," Finance and Stochastics, Springer, vol. 10(2), pages 250-275, April.
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    11. Masatoshi Fujisaki & Dewei Zhang, 2009. "Evaluation of the MEMM, Parameter Estimation and Option Pricing for Geometric Lévy Processes," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 16(2), pages 111-139, June.
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