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Valuing Options in Regime-Switching Models (1998)
| Venue: | Journal of Derivatives |
BibTeX
@ARTICLE{En98valuingoptions,
author = {Nicolas Boll En and Nicolas P. B. Bollen},
title = {Valuing Options in Regime-Switching Models},
journal = {Journal of Derivatives},
year = {1998},
volume = {6},
pages = {38--49}
}
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Abstract
This paper presents a lattice-based method for valuing both European and American-style options in regime-switching models. The Black-Scholes model is shown to generate significant pricing errors when a regime-switching process governs underlying asset returns. In addition, regime-switching option values are shown to generate implied volatility smiles commonly found in empirical studies. These results provide encouraging evidence that the valuation technique is important, and rich enough to capture salient features of traded option prices. Current Version: January 29, 1998 1 Valuing Options in Regime-Switching Models Regime-switching models effectively capture the complex time series properties of several important financial variables, including interest rates and exchange rates. Existing research develops the econometrics of regime-switching models and demonstrates their advantages over other models. However, option valuation in a regime-switching framework has received litt...
Keyphrases
regime-switching model implied volatility traded option price complex time series property option valuation black-scholes model several important financial variable interest rate american-style option salient feature valuation technique empirical study regime-switching process governs regime-switching framework regime-switching option value significant pricing error encouraging evidence current version exchange rate lattice-based method regime-switching model regime-switching model asset return
