A generalized Esscher transform for option valuation with regime switching risk

R. J. Elliott and Tak Kuen Siu

Quantitative Finance, 2022, vol. 22, issue 4, 691-705

Abstract: A generalized Esscher transform is introduced for option valuation in a Markov regime-switching model. It is intended that the generalized Esscher transform might provide novel insights into pricing regime switching risk. A new pricing kernel and the related martingale condition are derived which might provide a convenient way to price both diffusion and regime switching risks. Numerical studies are provided to illustrate the proposed method.

Date: 2022
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DOI: 10.1080/14697688.2021.2005251

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