A hybrid Markov chain-tree valuation framework for stochastic volatility jump diffusion models

Duy Nguyen ()
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Duy Nguyen: Department of Mathematics, Marist College, 3399 North Road, Poughkeepsie NY 12601, United States

International Journal of Financial Engineering (IJFE), 2018, vol. 05, issue 04, 1-30

Abstract: We develop a unified hybrid valuation framework for computing option values under stochastic volatility (SV) models with a jump component. The proposed method originates from the tree method and regime switching approximation. Conditions on the choices of key parameters for the tree design are provided to guarantee the positivity of branch probabilities. We also prove the weak convergence of the proposed method to the true stochastic models. Numerical results are provided to illustrate the effectiveness of the proposed method.

Keywords: Regime-switching model; recombining tree; options pricing; jump diffusion; Markov chain approximation; stochastic volatility model (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1142/S2424786318500391

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