WSEAS Transactions on Mathematics
Print ISSN: 1109-2769, E-ISSN: 2224-2880
Volume 16, 2017
Pricing Vulnerable European Options Under a Markov-Modulated Jump Diffusion Process
Authors: Wei Wang, Xiaonan Su, Shaobo Gan, Linyi Qian
Abstract: In this paper, we investigate the pricing of vulnerable European options under a Markov-modulated jump diffusion process. The states of market economy which are described by a two-state continuous time Markov-chain are explained as a stable state and a high volatility state. The dynamic of the risky asset is described by a Markov-modulated geometry Brownian motion when the market state is stable, otherwise, it follows a Markov-modulated jump diffusion process. We consider two types of models to describe default risk: one is the structural model, the other is the reduced form model. By utilizing techniques of measure changes, some analytic formulas for pricing vulnerable European options are derived under these models.
Search Articles
Keywords: Jump diffusion, Markov-modulated, Vulnerable options
Pages: 123-132
WSEAS Transactions on Mathematics, ISSN / E-ISSN: 1109-2769 / 2224-2880, Volume 16, 2017, Art. #15