Valuing Qualitative Options With Stochastic Volatility
Quantitative Finance, Vol 9, Issue 7, 2009
Posted: 27 Nov 2007 Last revised: 22 Oct 2010
Date Written: November 22, 2007
We find a closed-form formula for valuing a time-switch option where its underlying asset is affected by a stochastically changing market environment, and apply it to the valuation of other qualitative options such as corridor options and options in foreign exchange markets. The stochastic market environment is modeled as a Markov regime-switching process. This analytic formula provides us a rapid and accurate scheme for valuing qualitative options with stochastic volatility.
Keywords: qualitative option, stochastic volatility, regime-switching volatility, option valuation, Markov chain
JEL Classification: C63
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