On the regularity of American options with regime-switching uncertainty

DOI10.1016/J.SPA.2017.06.007zbMATH Open1395.91521arXiv1309.1404OpenAlexW2571794164MaRDI QIDQ681986FDOQ681986

Authors: Adriana Ocejo, S. D. Jacka 

Publication date: 13 February 2018

Published in: Stochastic Processes and their Applications (Search for Journal in Brave)

Abstract: We study the regularity of the stochastic representation of the solution of a class of initial-boundary value problems related to a regime-switching diffusion. This representation is related to the value function of a finite-horizon optimal stopping problem such as the price of an American-style option in finance. We show continuity and smoothness of the value function using coupling and time-change techniques. As an application, we find the minimal payoff scenario for the holder of an American-style option in the presence of regime-switching uncertainty under the assumption that the transition rates are known to lie within level-dependent compact sets.

Full work available at URL: https://arxiv.org/abs/1309.1404

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zbMATH Keywords

regime-switchingAmerican optioncouplinginitial-boundary value problemtime-changeMarkov-modulated

Mathematics Subject Classification ID

Applications of Brownian motions and diffusion theory (population genetics, absorption problems, etc.) (60J70) Smoothness and regularity of solutions to PDEs (35B65) Sample path properties (60G17) Processes in random environments (60K37) Financial applications of other theories (91G80) Control/observation systems governed by functional relations other than differential equations (such as hybrid and switching systems) (93C30)

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Cited In (8)

• General methods for bounding multidimensional ruin probabilities in regime-switching models
• Explicit solutions to utility maximization problems in a regime-switching market model via Laplace transforms
• Optimal selling strategies under regime-switching market environment with finite expiry
• Asian option as a fixed-point
• On Itô's formula for semimartingales with jumps and non-\(\mathcal{C}^2\) functions
• A spectral element method for option pricing under regime-switching with jumps
• American put option with regime‐switching volatility (finite time horizon)—Variational inequality approach
• Regularity of the free boundary of an American option on several assets

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