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Pricing barrier options by a regime switching model

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  • Pål Nicolai Henriksen

Abstract

This paper introduces a new way of estimating parameters in a Brownian motion regime switching asset model to incorporate volatility clustering. The regime switching model is then applied to pricing of up-and-in barrier call options. We take the probability of crossing the barrier between simulation points into account, and we increase accuracy in simulations by importance sampling. The regime switching model is compared to the Normal Inverse Gaussian model and the traditional Black-Scholes model, and option prices from the regime switching model are compared to the closed form expression of up-and-in barrier calls in a Black-Scholes market.

Suggested Citation

  • Pål Nicolai Henriksen, 2011. "Pricing barrier options by a regime switching model," Quantitative Finance, Taylor & Francis Journals, vol. 11(8), pages 1221-1231.
    • Handle: RePEc:taf:quantf:v:11:y:2011:i:8:p:1221-1231
    DOI: 10.1080/14697680903567160
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    References listed on IDEAS

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