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Option pricing under regime switching: Integration over simplexes method

Bong-Gyu Jang and Hyeon-Wuk Tae

Finance Research Letters, 2018, vol. 24, issue C, 301-312

Abstract: This paper aims to develop an alternative method for pricing European options under regime-switching market conditions by representing their values as a sum of integrations over simplexes. We calculate the integrations by using the method of Grundmann and Möller (1978). The method is applicable to the valuation of European-type options written on underlying assets whose prices follow a regime-switching mean-reverting process as well as a conventional regime-switching geometric Brownian motion. Numerical examples provide evidence that this method can be a powerful tool for practitioners in option pricing.

Keywords: Option pricing; Regime switch; Commodity option; Stochastic volatility; Integration over simplex (search for similar items in EconPapers)
JEL-codes: C63 G13 (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:finlet:v:24:y:2018:i:c:p:301-312