Option Pricing with Regime Switching: Integrations over Simplexes Method

Posted: 29 Nov 2015 Last revised: 16 Oct 2017

See all articles by Bong-Gyu Jang

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH)

Hyeon-Wuk Tae

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering

Date Written: April 1, 2017

Abstract

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

Suggested Citation

Jang, Bong-Gyu and Tae, Hyeon-Wuk, Option Pricing with Regime Switching: Integrations over Simplexes Method (April 1, 2017). Finance Research Letters, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2695939 or http://dx.doi.org/10.2139/ssrn.2695939

Bong-Gyu Jang (Contact Author)

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)

Hyeon-Wuk Tae

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering ( email )

77, Cheongam-ro, Nam-gu, Pohang-si, Gyeongsangbuk-
Pohang si, 37673
Korea, Republic of (South Korea)

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