State-dependent jump risks for American gold futures option pricing

Yu-Min Lian, Szu-Lang Liao and Jun-Home Chen

The North American Journal of Economics and Finance, 2015, vol. 33, issue C, 115-133

Abstract: In this study, we investigate the valuation of American-style options when the underlying gold futures price follows a pure diffusion structure with state-dependent jump dynamics. Under such dynamics, the jump events are described as a compound Poisson process with a log-normal jump amplitude, and the regime-switching arrival intensity is captured by a hidden Markov chain whose states represent the economic states. Considering the different jump risk assumptions, we use the Merton measure and Esscher transform to derive risk-neutral gold futures price dynamics under an incomplete market setting. To achieve a desired accuracy level, the least-squares Monte Carlo method is used to approximate the values of American gold futures options. Our empirical and numerical results based on actual market data are provided to illustrate the importance of incorporating state-dependent jump risks when pricing American put options on gold futures.

Keywords: State-dependent jump risk; American gold futures option; Merton measure; Esscher transform; Least-squares Monte Carlo method (search for similar items in EconPapers)
JEL-codes: C13 C15 G12 G13 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:33:y:2015:i:c:p:115-133

DOI: 10.1016/j.najef.2015.04.001

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