American Options in Regime-Switching Models

36 Pages Posted: 11 Sep 2006

See all articles by Svetlana Boyarchenko

Svetlana Boyarchenko

University of Texas at Austin - Department of Economics

Sergei Levendorskii

Calico Science Consulting

Date Written: September 6, 2006

Abstract

In the paper, we solve the pricing problem for American options in Markov-modulated Levy models. The early exercise boundaries and prices are calculated using a generalization of Carr's randomization for regime-switching models. The pricing procedure is efficient even if the number of states is large provided the transition rates are not large w.r.t. the riskless rates. The payoffs and riskless rates may depend on a state. Special cases are stochastic volatility models and models with stochastic interest rate; both must be modelled as finite-state Markov chains.

Keywords: optimal stopping, American options, finite time horizon, regime switching, Levy processes, stochastic volatility models, stochastic interest rate models

JEL Classification: D81, C61, G31

Suggested Citation

Boyarchenko, Svetlana I. and Levendorskii, Sergei Z., American Options in Regime-Switching Models (September 6, 2006). Available at SSRN: https://ssrn.com/abstract=929215 or http://dx.doi.org/10.2139/ssrn.929215

Svetlana I. Boyarchenko

University of Texas at Austin - Department of Economics ( email )

Austin, TX 78712
United States

Sergei Z. Levendorskii (Contact Author)

Calico Science Consulting ( email )

Austin, TX
United States

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