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Article: Option Pricing under a Stochastic Interest Rate and Volatility Model with Hidden Markovian Regime-switching

TitleOption Pricing under a Stochastic Interest Rate and Volatility Model with Hidden Markovian Regime-switching
Authors
KeywordsCharacteristic function
Fourier transformation
Hidden Markov model (HMM)
Option pricing
Regime-switching
Issue Date2019
PublisherSpringer New York LLC. The Journal's web site is located at http://springerlink.metapress.com/openurl.asp?genre=journal&issn=0927-7099
Citation
Computational Economics, 2019, v. 53 n. 2, p. 555-586 How to Cite?
AbstractIn this paper we discuss an option pricing problem in a hidden Markovian regime-switching model with a stochastic interest rate and volatility. Regime switches are attributed to structural changes in an hidden economic environment and are described by a continuous-time, finite-state, unobservable Markov chain. The model is then applied to the valuation of a standard European option. By means of the standard separation principle, filtering and option valuation problems are separated. Robust filters for the hidden states of the economy and their robust filtered estimates of unknown parameters from the expectation maximization algorithm are presented based on standard techniques in filtering theory. Then an explicit expression of a conditional characteristic function relevant to option pricing is presented and the valuation of the option is discussed using the inverse Fourier transformation approach. Using the limiting behavior of the conditional characteristic function, an efficient implementation of the transform inversion integral is considered. Numerical experiments are given to illustrate the flexibility of filtering algorithms and the significance of regime-switching in option pricing.
Persistent Identifierhttp://hdl.handle.net/10722/275052
ISSN
2017 Impact Factor: 1.038
2015 SCImago Journal Rankings: 0.240
ISI Accession Number ID

 

DC FieldValueLanguage
dc.contributor.authorZhu, D-
dc.contributor.authorLu, J-
dc.contributor.authorChing, WK-
dc.contributor.authorSiu, T-
dc.date.accessioned2019-09-10T02:34:27Z-
dc.date.available2019-09-10T02:34:27Z-
dc.date.issued2019-
dc.identifier.citationComputational Economics, 2019, v. 53 n. 2, p. 555-586-
dc.identifier.issn0927-7099-
dc.identifier.urihttp://hdl.handle.net/10722/275052-
dc.description.abstractIn this paper we discuss an option pricing problem in a hidden Markovian regime-switching model with a stochastic interest rate and volatility. Regime switches are attributed to structural changes in an hidden economic environment and are described by a continuous-time, finite-state, unobservable Markov chain. The model is then applied to the valuation of a standard European option. By means of the standard separation principle, filtering and option valuation problems are separated. Robust filters for the hidden states of the economy and their robust filtered estimates of unknown parameters from the expectation maximization algorithm are presented based on standard techniques in filtering theory. Then an explicit expression of a conditional characteristic function relevant to option pricing is presented and the valuation of the option is discussed using the inverse Fourier transformation approach. Using the limiting behavior of the conditional characteristic function, an efficient implementation of the transform inversion integral is considered. Numerical experiments are given to illustrate the flexibility of filtering algorithms and the significance of regime-switching in option pricing.-
dc.languageeng-
dc.publisherSpringer New York LLC. The Journal's web site is located at http://springerlink.metapress.com/openurl.asp?genre=journal&issn=0927-7099-
dc.relation.ispartofComputational Economics-
dc.rightsThis is a post-peer-review, pre-copyedit version of an article published in [insert journal title]. The final authenticated version is available online at: http://dx.doi.org/[insert DOI]-
dc.subjectCharacteristic function-
dc.subjectFourier transformation-
dc.subjectHidden Markov model (HMM)-
dc.subjectOption pricing-
dc.subjectRegime-switching-
dc.titleOption Pricing under a Stochastic Interest Rate and Volatility Model with Hidden Markovian Regime-switching-
dc.typeArticle-
dc.identifier.emailChing, WK: wching@hku.hk-
dc.identifier.authorityChing, WK=rp00679-
dc.description.naturelink_to_subscribed_fulltext-
dc.identifier.doi10.1007/s10614-017-9754-9-
dc.identifier.scopuseid_2-s2.0-85029755674-
dc.identifier.hkuros303660-
dc.identifier.volume53-
dc.identifier.issue2-
dc.identifier.spage555-
dc.identifier.epage586-
dc.identifier.isiWOS:000458498000004-
dc.publisher.placeUnited States-

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