Pricing Options under Telegraph Processes

Nikita Ratanov ()

Revista de Economía del Rosario, 2005, No 3373

Abstract: In this paper we introduce a financial market model based on continuous time random motions with alternating constant velocities and jumps, which occur with velocity switches. Given that jump directions match velocity directions of the underlying random motion properly in relation to interest rates, in this setting will be free of arbitrage. Additionally, we suppose also the interest rate depending on the market state. The replicating strategies for options are constructed in detail, and closed form formulas for option prices are obtained.

Keywords: jump telegraph process; European option pricing; perfect hedging; selffinancing strategy; fundamental equation (search for similar items in EconPapers)
JEL-codes: D8 G10 G12 (search for similar items in EconPapers)
Date: 2005
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Persistent link: https://EconPapers.repec.org/RePEc:col:000151:003373

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