A Discrete-Time Approach to Evaluate Path-Dependent Derivatives in a Regime-Switching Risk Model

Emilio Russo
Additional contact information
Emilio Russo: Department of Economics, Statistics and Finance, University of Calabria, Ponte Bucci cubo 1C, 87036 Rende (CS), Italy

Risks, 2020, vol. 8, issue 1, 1-22

Abstract: This paper provides a discrete-time approach for evaluating financial and actuarial products characterized by path-dependent features in a regime-switching risk model. In each regime, a binomial discretization of the asset value is obtained by modifying the parameters used to generate the lattice in the highest-volatility regime, thus allowing a simultaneous asset description in all the regimes. The path-dependent feature is treated by computing representative values of the path-dependent function on a fixed number of effective trajectories reaching each lattice node. The prices of the analyzed products are calculated as the expected values of their payoffs registered over the lattice branches, invoking a quadratic interpolation technique if the regime changes, and capturing the switches among regimes by using a transition probability matrix. Some numerical applications are provided to support the model, which is also useful to accurately capture the market risk concerning path-dependent financial and actuarial instruments.

Keywords: regime-switching risk; market risk; path-dependent derivatives; insurance policies; binomial lattices; discrete-time models (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://www.mdpi.com/2227-9091/8/1/9/pdf (application/pdf)
https://www.mdpi.com/2227-9091/8/1/9/ (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gam:jrisks:v:8:y:2020:i:1:p:9-:d:314174

Access Statistics for this article

Risks is currently edited by Mr. Claude Zhang

More articles in Risks from MDPI
Bibliographic data for series maintained by MDPI Indexing Manager ().