A hidden Markov regime-switching model for option valuation

Liew, Chuin Ching; Siu, Tak Kuen

doi:10.1016/j.insmatheco.2010.08.003

Cited by 25 publications

(13 citation statements)

References 37 publications

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“…Specifically, the transform can be computed easily, even for general semimartingales, because the whole density process is given in a form of Girsanov's theorem, which can be used conveniently. In addition, Liew and Siu (2010) showed that the Esscher transform and extended Girsanov's principle under the HMM model lead to the same pricing result. Elliott et al (2007) used the Esscher transform to price options under a generalized MMJDM with a constant interest rate.…”

Section: Change Of Numerairementioning

confidence: 96%

Pricing credit-risky bonds and spread options modelling credit-spread term structures with two-dimensional Markov-modulated jump-diffusion

Chen

Hsu

2015

Quantitative Finance

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The relationship between company hazard rates and the business cycle becomes more apparent after a financial crisis. To address this relationship, a regime-switching process with an intensity function is adopted in this paper. In addition, the dynamics of both interest rates and asset values are modelled with a Markov-modulated jump-diffusion model, and a 2-factor hazard rate model is also considered. Based on this more suitable model setting, a closed-form model of pricing risky bonds is derived. The difference in yield between a risky bond and risk-free zero coupon bond is used to model a term structure of credit spreads (CSs) from which a closed-form pricing model of a call option on CSs is obtained. In addition, the degree to which the explicit regime shift affects CSs and credit-risky bond prices is numerically examined using three forward-rate functions under various business-cycle patterns.

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Section: Change Of Numerairementioning

confidence: 96%

Pricing credit-risky bonds and spread options modelling credit-spread term structures with two-dimensional Markov-modulated jump-diffusion

Chen

Hsu

2015

Quantitative Finance

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“…Due to their empirical successes, Markovian switching models have found diverse applications in economics and management science. They have been successfully applied to different important areas of research, such as asset allocation (e.g., Korn et al., ; Bae et al., ), option valuation (e.g., Liew and Siu, ; Alavifard and Siu, ), macroeconomics (e.g., Hamilton, , ), and actuarial science (e.g., Alavifard and Siu, ; Alavifard and Rong, ).…”

Section: Literature Reviewmentioning

confidence: 99%

“…In option pricing literature, the conventional method of calibrating HMM is to use the market prices of the underlying instrument as the observation process (cf. Liew and Siu, ). This method would not yield accurate results for real options because the underlying asset (i.e., the cash flow) is unobserved.…”

Section: Modeling Opec's Oligopoly Via Hmmmentioning

confidence: 99%

Optimal divestment time in supply chain redesign under oligopoly: evidence from shale oil production plants

Alavifard¹,

Ivanov

2019

Int Trans Operational Res

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This paper investigates the optimal timing for the closure of production plants in the context of supply chain redesign. We consider producers operating under oligopoly and analyze their optimal decisions with the aid of real options. We contextualize this study in the energy supply chain, where revenue is heavily influenced by the Organization of the Petroleum Exporting Countries (OPEC). It is optimal to divest from a production if certain values pass below the liquidation cost. The optimal time to divest is, then, the optimal time to exercise a perpetual American put option on the total value of the project, where the strike price is the liquidation value and expenses. The OPEC oligpolistic power is modeled with the aid of a hidden market in a Hidden Markov Model, since the state of the Markov chain is not directly visible to the production manager. The reported results can be used by supply chain managers in decision making on production network redesign in the oligopolistic environment considering present value of plants and cash flows in the supply chain. The advantage of the modeling approach proposed is its analytical tractability, especially for project valuation and real-option problems.

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“…Under the assumption of a two-state economy, an analytical approximation for the price of an American option has also been obtained in Buffington and Elliott (2002) and an explicit formula, in terms of infinite series, in Chan and Zhu (2021) by means of the homotopy analysis. As regime-switching models often result in an incomplete market, Liew and Siu (2010) have investigated two approaches in selecting the equivalent martingale measure to option valuation. We refer to the collective books by Elliott (2007, 2014) and references therein for an overview of hidden Markov models in Finance.…”

Section: Introductionmentioning

confidence: 99%

Properties of American options under a Markovian Regime Switching Model

Dimitrov

Jin

2021

Communications in Statistics: Case Studies, Data Analysis and A

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In this article, a model under which the underlying asset follows a Markov regime-switching process is considered. The underlying economy is partially observable in a form of a signal stochastically related to the actual state of the economy. The American option pricing problem is formulated using a partially observable Markov decision process (POMDP). Through the article, a threestate economy is assumed with a focus on the threshold for the early exercise, hold regions and its monotonicity. An extensive numerical experimental study is conducted in order to clarify the relationship between the monotonicity of the exercising strategy and the sufficient conditions which are obtained in Jin, Dimitrov, and Ni. In this article, the effect of sufficient conditions is confirmed. It was shown that sufficient conditions are not necessary for the monotonicity of the exercising strategy, and a discussion including milder conditions is presented based on the numerical studies.

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A hidden Markov regime-switching model for option valuation

Cited by 25 publications

References 37 publications

Pricing credit-risky bonds and spread options modelling credit-spread term structures with two-dimensional Markov-modulated jump-diffusion

Pricing credit-risky bonds and spread options modelling credit-spread term structures with two-dimensional Markov-modulated jump-diffusion

Optimal divestment time in supply chain redesign under oligopoly: evidence from shale oil production plants

Properties of American options under a Markovian Regime Switching Model

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