Option pricing model based on a Markov-modulated diffusion with jumps
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Publication:985996
DOI10.1214/09-BJPS037zbMATH Open1193.91158arXiv0812.0761MaRDI QIDQ985996FDOQ985996
Publication date: 9 August 2010
Published in: Brazilian Journal of Probability and Statistics (Search for Journal in Brave)
Abstract: The paper proposes a class of financial market models which are based on inhomogeneous telegraph processes and jump diffusions with alternating volatilities. It is assumed that the jumps occur when the tendencies and volatilities are switching. We argue that such a model captures well the stock price dynamics under periodic financial cycles. The distribution of this process is described in detail. For this model we obtain the structure of the set of martingale measures. This incomplete model can be completed by adding another asset based on the same sources of randomness. Explicit closed-form formulae for prices of the standard European options are obtained for the completed market model.
Full work available at URL: https://arxiv.org/abs/0812.0761
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