Good-Deal Bounds in a Regime-Switching Diffusion Market

Catherine Donnelly

Applied Mathematical Finance, 2011, vol. 18, issue 6, 491-515

Abstract: We consider option pricing in a regime-switching diffusion market. As the market is incomplete, there is no unique price for a derivative. We apply the good-deal pricing bounds idea to obtain ranges for the price of a derivative. As an illustration, we calculate the good-deal pricing bounds for a European call option and we also examine the stability of these bounds when we change the generator of the Markov chain which drives the regime-switching. We find that the pricing bounds depend strongly on the choice of the generator.

Date: 2011
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DOI: 10.1080/1350486X.2011.591156

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