How does economic volatility affect option pricing? This study considers a Black-Scholes market where the underlying economy, as modeled by the processes and volatility of the parameters, switches between a finite number of states, which are then modeled by a hidden Markov chain. It extends this framework to approximate the valuation of American options in this complex setting. The research considers a specific situation where parameters and volatility vary based on a hidden Markov chain, that can switch between a finite number of states. Black-Scholes model and pricing are obtained. Findings from this research can lead to improved understanding on American options. From those improvements, it's possible to have better predictions on market outcomes in real world situations where the underlying economy shifts between a number of states.
Published in the International Journal of Theoretical and Applied Finance, this article addresses option pricing in financial markets. By looking at how the economy can shift in several different states and switch up volatility, the model presented is highly relevant. To what extend do these finding work?
| Category | Category Repetition |
|---|---|
| Science: Mathematics | 3 |
| Science: Science (General) | 2 |
| Technology: Engineering (General). Civil engineering (General) | 1 |