Functional of the Diffusion Path of a Two-State Markov-Chain Model for Option Pricing

15 Pages Posted: 27 Mar 2013

See all articles by James Redekop

James Redekop

Independent

Tony S. Wirjanto

University of Waterloo - School of Accounting and Finance; University of Waterloo, Department of Statistics & Actuarial Science

Date Written: March 26, 2013

Abstract

This paper studies the functional of the path of a diffusion in which volatility switches between two states: high and low. For this two-state Markov-chain model, we derive a closed-form expression for the distribution function for the time spent in the high volatility state by guessing the form of, and calculating the coefficients in, the solution to a pair of integral equations.

Keywords: Markov-chain, diffusion, volatility, density

JEL Classification: C61, G11, G12, G13

Suggested Citation

Redekop, James and Wirjanto, Tony S., Functional of the Diffusion Path of a Two-State Markov-Chain Model for Option Pricing (March 26, 2013). Available at SSRN: https://ssrn.com/abstract=2240044 or http://dx.doi.org/10.2139/ssrn.2240044

James Redekop

Independent

Tony S. Wirjanto (Contact Author)

University of Waterloo - School of Accounting and Finance ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)

HOME PAGE: http://https://uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

University of Waterloo, Department of Statistics & Actuarial Science ( email )

200 University Avenue West
Waterloo, Ontario N2L 3G1
Canada
519-888-4567 x35210 (Phone)
519-746-1875 (Fax)

HOME PAGE: http://math.uwaterloo.ca/statistics-and-actuarial-science/people-profiles/tony-wirjanto

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