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Double Barrier Options In Regime-Switching Hyper-Exponential Jump-Diffusion Models

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    (Department of Mathematics, University of Michigan, 530 Church Street, 2074 East Hall, Ann Arbor, MI 48109-1043, USA)



    (Department of Economics, The University of Texas at Austin, 1 University Station C3100, Austin, TX 78712–0301, USA)

We present a very fast and accurate algorithm for calculating prices of finite lived double barrier options with arbitrary terminal payoff functions under regime-switching hyper-exponential jump-diffusion (HEJD) models, which generalize the double-exponential jump-diffusion model pioneered by Kou and Lipton. Numerical tests demonstrate an excellent agreement of our results with those obtained using other methods, as well as a significant increase in computation speed (sometimes by a factor of 5). The first step of our approach is Carr's randomization, whose convergence we prove for barrier and double barrier options under strong Markov processes of a wide class. The resulting sequence of perpetual option pricing problems is solved using an efficient iteration algorithm and the Wiener-Hopf factorization.

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Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Journal of Theoretical and Applied Finance (IJTAF).

Volume (Year): 14 (2011)
Issue (Month): 07 ()
Pages: 1005-1043

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Handle: RePEc:wsi:ijtafx:v:14:y:2011:i:07:n:s0219024911006620
DOI: 10.1142/S0219024911006620
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