Option pricing with regime switching tempered stable processes

Zuodong Lin, Svetlozar T. Rachev, Young Shin Kim and Frank Fabozzi ()

No 43, Working Paper Series in Economics from Karlsruhe Institute of Technology (KIT), Department of Economics and Management

Abstract: In this paper we will introduce a hybrid option pricing model that combines the classical tempered stable model and regime switching by a hidden Markov chain. This model allows the description of some stylized phenomena about asset return distributions that are well documented in financial markets such as time-varying volatility, skewness, and heavy tails.We will derive the option pricing formula under the this model by means of Fourier transform method. In order to demonstrate the superior accuracy and the capacity of capturing dynamics using the proposed model, we will empirically test the model using call option prices where the underlying is the S&P 500 Index.

Date: 2012
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:kitwps:43

DOI: 10.5445/IR/1000029302

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