An FFT approach for option pricing under a regime-switching stochastic interest rate model. Issue 11 (3rd June 2017)

• Record Type: Journal Article
• Authors: Fan, Kun; Shen, Yang; Siu, Tak Kuen; Wang, Rongming
• Is Part Of: Communications in statistics. Volume 46:Issue 11(2017)
• Page Start: 5292
• Page End: 5310
• Publication Date: 2017-06-03
• Subjects: Fast Fourier transform -- Forward measure -- Regime-switching -- Stochastic interest rate.; 91G20 -- 91G30 -- 91G60; Mathematical statistics -- Periodicals; Mathematics; Statistics; 519.2
• DOI: 10.1080/03610926.2015.1100740
• Languages: English
• ISSNs: 0361-0926

Abstract

ABSTRACT: In this article, we investigate the pricing of European-style options under a Markovian regime-switching Hull–White interest rate model. The parameters of this model, including the mean-reversion level, the volatility of the stochastic interest rate, and the volatility of an asset's value, are modulated by an observable, continuous-time, finite-state Markov chain. A closed-form expression for the characteristic function of the logarithmic terminal asset price is derived. Then, using the fast Fourier transform, a price of a European-style option is computed. In a two-state Markov chain case, numerical examples and empirical studies are presented to illustrate the practical implementation of the model.