Pricing gold options under Markov-modulated jump-diffusion processes

Shih-Kuei Lin, Yu-Min Lian and Szu-Lang Liao

Applied Financial Economics, 2014, vol. 24, issue 12, 825-836

Abstract: In this study, we empirically investigate the properties of gold returns, and the European gold options are priced when the underlying gold price dynamics are driven by Markov-modulated jump-diffusion processes. Specifically, the jump events are captured by a compound Poisson process with a log-normal jump size, and the regime-switching intensity rate is governed by a continuous-time finite-state Markov chain. Under an incomplete market setting, we study the valuation of European gold options using the method of Esscher transform. The estimated results and numerical examples are provided.

Date: 2014
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DOI: 10.1080/09603107.2014.914142

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