On the regularity of American options with regime-switching uncertainty

Saul D. Jacka and Adriana Ocejo

Stochastic Processes and their Applications, 2018, vol. 128, issue 3, 803-818

Abstract: We study the regularity of the stochastic representation of the solution of a class of initial–boundary value problems related to a regime-switching diffusion. This representation is related to the value function of a finite-horizon optimal stopping problem such as the price of an American-style option in finance. We show continuity and smoothness of the value function using coupling and time-change techniques. As an application, we find the minimal payoff scenario for the holder of an American-style option in the presence of regime-switching uncertainty under the assumption that the transition rates are known to lie within level-dependent compact sets.

Keywords: Regime-switching; Markov-modulated; Time-change; Coupling; American option; Initial–boundary value problem (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:spapps:v:128:y:2018:i:3:p:803-818

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DOI: 10.1016/j.spa.2017.06.007

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