Analysis about the Black-Scholes asset price under the regime-switching framework

Ping Tian, Hang Zhou and Duotai Zhou

International Review of Financial Analysis, 2023, vol. 88, issue C

Abstract: Assuming that the macroeconomic environment can be transformed into a two-district system, that is, the path of financial asset prices is uncertain, we track and study the motion of stocks and other asset price process under the conditional Black-Scholes model, and give the economical explanation of the mathematical formula. Further, we derive and analyze an option pricing formula for the Black-Scholes asset model under the condition that the risk-free interest rate is regime-switching too. The method in this article is applied to model the log rate of return of the Tencent stock in a two-district market environment. And the obtained parameter values are used to calculate the option price. In narrowing the gap with actual option prices, our method outperforms the classical option pricing model point by point. Compared with the general and pure mathematical model derived work and the empirical study work, our study does more work on the economic characteristics analysis and interpretation of the mathematical models, and plays a certain role in linking the results of mathematical models with empirical research.

Keywords: Regime-switching; Black-Scholes model; Markov switching model; Option pricing (search for similar items in EconPapers)
JEL-codes: C32 G13 G23 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:88:y:2023:i:c:s1057521923002090

DOI: 10.1016/j.irfa.2023.102693

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