IDEAS home Printed from https://ideas.repec.org/a/taf/apmtfi/v18y2011i6p473-490.html
   My bibliography  Save this article

Option Valuation with a Discrete-Time Double Markovian Regime-Switching Model

Author

Listed:
  • Tak Kuen Siu
  • Eric S. Fung
  • Michael K. Ng

Abstract

This article develops an option valuation model in the context of a discrete-time double Markovian regime-switching (DMRS) model with innovations having a generic distribution. The DMRS model is more flexible than the traditional Markovian regime-switching model in the sense that the drift and the volatility of the price dynamics of the underlying risky asset are modulated by two observable, discrete-time and finite-state Markov chains, so that they are not perfectly correlated. The states of each of the chains represent states of proxies of (macro)economic factors. Here we consider the situation that one (macro)economic factor is caused by the other (macro)economic factor. The market model is incomplete, and so there is more than one equivalent martingale measure. We employ a discrete-time version of the regime-switching Esscher transform to determine an equivalent martingale measure for valuation. Different parametric distributions for the innovations of the price dynamics of the underlying risky asset are considered. Simulation experiments are conducted to illustrate the implementation of the model and to document the impacts of the macroeconomic factors described by the chains on the option prices under various different parametric models for the innovations.

Suggested Citation

  • Tak Kuen Siu & Eric S. Fung & Michael K. Ng, 2011. "Option Valuation with a Discrete-Time Double Markovian Regime-Switching Model," Applied Mathematical Finance, Taylor & Francis Journals, vol. 18(6), pages 473-490, March.
    • Handle: RePEc:taf:apmtfi:v:18:y:2011:i:6:p:473-490
    DOI: 10.1080/1350486X.2011.578457
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1080/1350486X.2011.578457
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1080/1350486X.2011.578457?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Godin, Frédéric & Trottier, Denis-Alexandre, 2021. "Option pricing in regime-switching frameworks with the Extended Girsanov Principle," Insurance: Mathematics and Economics, Elsevier, vol. 99(C), pages 116-129.
    2. Tak Kuen Siu & Robert J. Elliott, 2019. "Hedging Options In A Doubly Markov-Modulated Financial Market Via Stochastic Flows," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(08), pages 1-41, December.
    3. Godin, Frédéric & Lai, Van Son & Trottier, Denis-Alexandre, 2019. "Option pricing under regime-switching models: Novel approaches removing path-dependence," Insurance: Mathematics and Economics, Elsevier, vol. 87(C), pages 130-142.
    4. Frédéric Godiny & Van Son Lai & Denis-Alexandre Trottier, 2019. "Option Pricing Under Regime-Switching Models: Novel Approaches Removing Path-Dependence," Working Papers 2019-014, Department of Research, Ipag Business School.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:apmtfi:v:18:y:2011:i:6:p:473-490. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Longhurst (email available below). General contact details of provider: http://www.tandfonline.com/RAMF20 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.