On pricing and hedging options in regime-switching models with feedback effect

Robert J. Elliott, Tak Kuen Siu and Alexandru Badescu

Journal of Economic Dynamics and Control, 2011, vol. 35, issue 5, 694-713

Abstract: We study the pricing and hedging of European-style derivative securities in a Markov, regime-switching, model with a feedback effect depending on the economic condition. We adopt a pricing kernel which prices both financial and economic risks explicitly in a dynamically incomplete market and we provide an equilibrium analysis. A martingale representation for a European-style index option's price is established based on the price kernel. The martingale representation is then used to construct the local risk-minimizing strategy explicitly and to characterize the corresponding pricing measure.

Keywords: Pricing; and; hedging; Regime-switching; Feedback; effect; Product; price; kernel; Local; risk-minimization (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:35:y:2011:i:5:p:694-713

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