Option Pricing with Regime Switching: Integrations over Simplexes Method
Posted: 29 Nov 2015 Last revised: 16 Oct 2017
Date Written: April 1, 2017
This paper presents a new method for evaluating European options with regime switching. We represent their value as a sum of integrations over simplexes and show the integrations can be approximated by the method of Grundmann and Moller (1978). The method is applicable to the valuation of European-type options written on the underlying asset whose price follows a regime-switching mean-reverting process as well as a classical regime-switching geometric Brownian motion. Numerical examples give us evidences that it can be a powerful tool for practitioners in option pricing.
Keywords: option pricing, regime switching, simplex approach, commodity
JEL Classification: C63, G13
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