A RECOMBINING TREE METHOD FOR OPTION PRICING WITH STATE-DEPENDENT SWITCHING RATES

J. X. Jiang (), R. H. Liu () and D. Nguyen
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J. X. Jiang: School of Systems and Enterprises, Stevens Institute of Technology, Castle Point on the Hudson, NJ 07030, USA
R. H. Liu: Department of Mathematics, University of Dayton, 300 College Park, Dayton, OH 45469, USA
D. Nguyen: Department of Mathematics, Marist College, 3399 North Road, Poughkeepsie, NY 12601, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2016, vol. 19, issue 02, 1-26

Abstract: This paper develops simple and efficient tree approaches for option pricing in switching jump diffusion models where the rates of switching are assumed to depend on the underlying asset price process. The models generalize many existing models in the literature and in particular, the Markovian regime-switching models with jumps. The proposed trees grow linearly as the number of tree steps increases. Conditions on the choices of key parameters for the tree design are provided that guarantee the positivity of branch probabilities. Numerical results are provided and compared with results reported in the literature for the Markovian regime-switching cases. The reported numerical results for the state-dependent switching models are new and can be used for comparison in the future.

Keywords: Regime-switching models; recombining trees; option pricing; jump diffusions (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (4)

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DOI: 10.1142/S0219024916500126

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