On the regularity of American options with regime-switching uncertainty
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Publication:681986
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)
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.
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Cited in
(8)- Optimal selling strategies under regime-switching market environment with finite expiry
- Explicit solutions to utility maximization problems in a regime-switching market model via Laplace transforms
- Regularity of the free boundary of an American option on several assets
- General methods for bounding multidimensional ruin probabilities in regime-switching models
- A spectral element method for option pricing under regime-switching with jumps
- Asian option as a fixed-point
- On Itô's formula for semimartingales with jumps and non-\(\mathcal{C}^2\) functions
- American put option with regime‐switching volatility (finite time horizon)—Variational inequality approach
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