An Analytic Valuation Method for Multivariate Contingent Claims with Regime-Switching Volatilities
Opertations Research Letters, Vol. 39, Issue 3, 2011
Posted: 25 Mar 2009 Last revised: 22 Aug 2011
Date Written: March 25, 2009
In this paper, we provide an analytic valuation method for European-type contingent claims written on multiple assets in a stochastic market environment. We employ a two-state Markov regime-switching volatility in order to reflect the stochastically-changing market condition. The method is developed by exploiting the probability density of the occupation time for which the underlying asset processes are in a certain regime during a time period. In order to show its usefulness, we derive closed-form valuation formulas for quanto options and exchange options with two underlying assets, as examples. In addition, we develop an approximation formula for valuing a wide range of financial contingent claims written on more than two underlying assets.
Keywords: Multivariate Contingent Claim, Drivative Pricing, Regime Switch, Business Cycle, Stochastic Volaltility
JEL Classification: C63, G13
Suggested Citation: Suggested Citation