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Explicit solutions to European options in a regime-switching economy |
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| Authors: | Rogemar S. Mamon Marianito R. Rodrigo |
| Affiliation: | a CARISMA, School of Information Systems, Computing and Mathematics, Brunel University, West London, Uxbridge UB8 3PH, United Kingdom b Departamento Académico de Matemáticas, Instituto Tecnológico Autónomo de México, México |
| Abstract: | We provide closed-form solutions for European option values when the dynamics of both the short rate and volatility of the underlying price process are modulated by a continuous-time Markov chain with a finite number of “economic states”. Extensions involving dividends, currencies and cost of carry are further explored. |
| Keywords: | Black-Scholes PDE Option pricing Regime-switching model Markov chain in continuous time |
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