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Pricing foreign equity options under a regime-switching model with liquidity risk and default risk

Author

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  • Shengjie Yue
  • Chaoqun Ma
  • Chao Deng
  • Xinwei Zhao

Abstract

This article focuses on the pricing problem of foreign equity options under a Markovian regime-switching model with liquidity risk and default risk. Some basic parameters of foreign equity price, foreign exchange rate, and counterparty’s asset value are controlled by a continuous-times Markov chain. We adopt the liquidity discount factor to describe effects of the market liquidity on foreign equity price and counterparty’s asset value. The regime-switching Esscher transform is used to derive a risk-neutral measure. Based on the proposed pricing framework, we provide an explicit pricing formula for foreign equity options with default risk via the Fourier transform technique. Finally, numerical analysis is presented to illustrate the effects of regime-switching, liquidity risk, and default risk on the option price.

Suggested Citation

  • Shengjie Yue & Chaoqun Ma & Chao Deng & Xinwei Zhao, 2025. "Pricing foreign equity options under a regime-switching model with liquidity risk and default risk," Communications in Statistics - Theory and Methods, Taylor & Francis Journals, vol. 54(16), pages 4981-5005, August.
    • Handle: RePEc:taf:lstaxx:v:54:y:2025:i:16:p:4981-5005
    DOI: 10.1080/03610926.2024.2430740
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