An Analytic Approach for Pricing American Options with Regime Switching

An Analytic Approach for Pricing American Options with Regime Switching

This paper investigates the American option price in a two-state regime-switching model. The dynamics of underlying are driven by a Markov-modulated Geometric Wiener process. That means the interest rate, the appreciation rate, and the volatility of underlying rely on hidden states of the economy wh...

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Bibliographic Details
Main Authors: Leunglung Chan, Song-Ping Zhu
Format: Article
Language:English
Published: MDPI AG 2021-04-01
Series:Journal of Risk and Financial Management
Subjects:
option pricing
free boundary problem
regime switching
homotopy analysis method
Online Access:https://www.mdpi.com/1911-8074/14/5/188
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spelling doaj-2689aaad20774fbcaed47ec422aaadbb2021-04-21T23:02:25ZengMDPI AGJournal of Risk and Financial Management1911-80661911-80742021-04-011418818810.3390/jrfm14050188An Analytic Approach for Pricing American Options with Regime SwitchingLeunglung Chan0Song-Ping Zhu1School of Mathematics and Statistics, University of New South Wales, Sydney, NSW 2052, AustraliaSchool of Mathematics and Applied Statistics, University of Wollongong, Wollongong, NSW 2522, AustraliaThis paper investigates the American option price in a two-state regime-switching model. The dynamics of underlying are driven by a Markov-modulated Geometric Wiener process. That means the interest rate, the appreciation rate, and the volatility of underlying rely on hidden states of the economy which can be interpreted in terms of Markov chains. By means of the homotopy analysis method, an explicit formula for pricing two-state regime-switching American options is presented.https://www.mdpi.com/1911-8074/14/5/188option pricingfree boundary problemregime switchinghomotopy analysis method
collection DOAJ
language English
format Article
sources DOAJ
author Leunglung Chan
Song-Ping Zhu
spellingShingle Leunglung Chan
Song-Ping Zhu
An Analytic Approach for Pricing American Options with Regime Switching
Journal of Risk and Financial Management
option pricing
free boundary problem
regime switching
homotopy analysis method
author_facet Leunglung Chan
Song-Ping Zhu
author_sort Leunglung Chan
title An Analytic Approach for Pricing American Options with Regime Switching
title_short An Analytic Approach for Pricing American Options with Regime Switching
title_full An Analytic Approach for Pricing American Options with Regime Switching
title_fullStr An Analytic Approach for Pricing American Options with Regime Switching
title_full_unstemmed An Analytic Approach for Pricing American Options with Regime Switching
title_sort analytic approach for pricing american options with regime switching
publisher MDPI AG
series Journal of Risk and Financial Management
issn 1911-8066
1911-8074
publishDate 2021-04-01
description This paper investigates the American option price in a two-state regime-switching model. The dynamics of underlying are driven by a Markov-modulated Geometric Wiener process. That means the interest rate, the appreciation rate, and the volatility of underlying rely on hidden states of the economy which can be interpreted in terms of Markov chains. By means of the homotopy analysis method, an explicit formula for pricing two-state regime-switching American options is presented.
topic option pricing
free boundary problem
regime switching
homotopy analysis method
url https://www.mdpi.com/1911-8074/14/5/188
work_keys_str_mv AT leunglungchan ananalyticapproachforpricingamericanoptionswithregimeswitching
AT songpingzhu ananalyticapproachforpricingamericanoptionswithregimeswitching
AT leunglungchan analyticapproachforpricingamericanoptionswithregimeswitching
AT songpingzhu analyticapproachforpricingamericanoptionswithregimeswitching
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