International Journal of Theoretical and Applied Finance · 2002 · 521 citations · 4 references
BusinessFinanceMathematicsFinancial EconomicsQuantitative FinanceStochastic ProcessesHidden Markov ModelsMarkov ChainsOption PricingOption Pricing ModelsOptions MarketsRegime-switching ModelsBlack-scholes ModelBlack-scholes Valuation ModelEuropean Option PricingHidden Markov AnalysisOption Pricing TheoryOption Pricing Under Stochastic VolatilityOption Pricing ValuationRegime-switching Volatility Models
A Black-Scholes market is considered in which the underlying economy, as modeled by the parameters and volatility of the processes, switches between a finite number of states. The switching is modeled by a hidden Markov chain. European options are priced and a Black-Scholes equation obtained. The approximate valuation of American options due to Barone-Adesi and Whaley is extended to this setting.
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