Regime-switching option pricing models

Christoforidou, Amalia (2015) Regime-switching option pricing models. PhD thesis, University of Glasgow.

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Abstract

Part I: This chapter develops a lattice method for option evaluation aiming to investigate whether the option prices reflect the shifts in the distributions of the underlying asset returns and the risk-free interest rate. More precisely we try to investigate whether the option prices reflect the switches in the correlation between the underlying and risk-free bond returns that characterise different states of the economy. For this reason we develop and test two models. In the first model we allow all the parameters to follow a regime-switching process while in the second model, in order to isolate the regime-switching correlation effect on the option prices, we allow only the correlation to follow a regime-switching process. The models developed use pentanomial lattices to represent the evolution of the regime-switching underlying assets. Our findings suggest that the option prices reflect the regime-switches and that a model which considers these switches could produce more accurate results than a single-regime model. Part II: This part develops a class of closed-form models for options on commodities evaluation under the assumptions of mean-reversion in the commodity prices and factors’ values and regime-switching in the volatilities and correlations. At first we develop novel closed-form solutions of the 1-, 2- and 3-factors models and later in the paper these three models are transformed into regime switching models. The six models (three with and three without regime-switching) are then tested and compared on real market data. Our findings suggest that the by increasing the stochastic factors and assuming regime-switching in the models their flexibility and thus their accuracy increases.

Item Type: Thesis (PhD)
Qualification Level: Doctoral
Subjects: H Social Sciences > HD Industries. Land use. Labor > HD61 Risk Management
H Social Sciences > HG Finance
Q Science > QA Mathematics
Colleges/Schools: College of Social Sciences > Adam Smith Business School > Economics
Funder's Name: UNSPECIFIED
Supervisor's Name: Ewald, Dr. Christian and Sermpinis, Dr. Georgios
Date of Award: 2015
Depositing User: Dr Amalia Christoforidou
Unique ID: glathesis:2015-6684
Copyright: Copyright of this thesis is held by the author.
Date Deposited: 29 Oct 2015 13:58
Last Modified: 22 Dec 2015 15:48
URI: http://theses.gla.ac.uk/id/eprint/6684

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