Pricing double barrier options under a volatility regime-switching model with psychological barriers

Shiyu Song () and Yongjin Wang
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Shiyu Song: Tianjin University
Yongjin Wang: Nankai University

Review of Derivatives Research, 2017, vol. 20, issue 3, No 3, 255-280

Abstract: Abstract The prices of lots of assets have been proved in literature to exhibit special behaviors around psychological barriers, which is an important fact needed to be considered when pricing derivatives. In this paper, we discuss the valuation problem of double barrier options under a volatility regime-switching model where there exist psychological barriers in the prices of underlying assets. The volatility can shift between two regimes, that is to say, when the asset price rises up or falls down through the psychological barrier, the volatility takes two different values. Using the Laplace transform approach, we obtain the price of the double barrier knock-out call option as well as its delta. We also provide the eigenfunction expansion pricing formula and examine the effect of the psychological barrier on the option price and delta, finding that the gamma of the option is discontinuous at such barriers.

Keywords: Double barrier option; Psychological barrier; Regime switching; Laplace transform; Delta; Eigenfunction expansion (search for similar items in EconPapers)
JEL-codes: G13 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s11147-017-9130-x

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