An FFT approach for option pricing under a regime-switching stochastic interest rate model

Kun Fan, Yang Shen, Tak Kuen Siu and Rongming Wang

Communications in Statistics - Theory and Methods, 2017, vol. 46, issue 11, 5292-5310

Abstract: In this article, we investigate the pricing of European-style options under a Markovian regime-switching Hull–White interest rate model. The parameters of this model, including the mean-reversion level, the volatility of the stochastic interest rate, and the volatility of an asset’s value, are modulated by an observable, continuous-time, finite-state Markov chain. A closed-form expression for the characteristic function of the logarithmic terminal asset price is derived. Then, using the fast Fourier transform, a price of a European-style option is computed. In a two-state Markov chain case, numerical examples and empirical studies are presented to illustrate the practical implementation of the model.

Date: 2017
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:taf:lstaxx:v:46:y:2017:i:11:p:5292-5310

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DOI: 10.1080/03610926.2015.1100740

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