European Option Pricing under the Structural Time Series and Markov Regime-switching Model
Journal Title: Financial Forum - Year 2018, Vol 7, Issue 1
Abstract
We present closed-form formulas for the valuation of a European call option whose underlying process is assumed to follow structural time series and the Markov regime-switching process through mean reversion described by a harmonic oscillator. In our model, each parameter has related corresponding economic meaning, and this leads to an easy analy-sis of the interplay between the option and business cycles. Forward rates are assumed under the Heath et al. (1992) HJM framework. The call option analytic formulas are obtained when the joint distribution of occupation times is specified and forward rates are restricted in a one-factor HJM model.
Authors and Affiliations
Pao-Peng Hsu, Che-Yang Lin
Keywords
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- EP ID EP680178
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European Option Pricing under the Structural Time Series and Markov Regime-switching Model
We present closed-form formulas for the valuation of a European call option whose underlying process is assumed to follow structural time series and the Markov regime-switching process through mean reversion described by...