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Option Pricing in a Regime Switching Stochastic Volatility Model

Arunangshu Biswas, Anindya Goswami and Ludger Overbeck

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Abstract: In the classical model of stock prices which is assumed to be Geometric Brownian motion, the drift and the volatility of the prices are held constant. However, in reality, the volatility does vary. In quantitative finance, the Heston model has been successfully used where the volatility is expressed as a stochastic differential equation. In addition, we consider a regime switching model where the stock volatility dynamics depends on an underlying process which is possibly a non-Markov pure jump process. Under this model assumption, we find the locally risk minimizing pricing of European type vanilla options. The price function is shown to satisfy a Heston type PDE.

New Economics Papers: this item is included in nep-rmg
Date: 2017-07, Revised 2018-01
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