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Optimal investment of variance-swaps in jump-diffusion market with regime-switching

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  • Bo, Lijun
  • Tang, Dan
  • Wang, Yongjin

Abstract

We consider a general jump-diffusion market with regime-switching where the jump risk is modeled as a Markov-modulated Poisson random measure. In this incomplete market, we price the variance-swaps using a combination of the Esscher transform and change of measure on time-inhomogeneous Markov chains. We study the dynamic optimal investment problem of the variance-swaps and characterize the optimal feedback strategy. Moreover, a closed-form solution to the HJB PDE associated with the stochastic control problem is established and the verification theorem is proved. The numerical analysis based on a two-state Markov chain uncovers some robust features of the optimal investment strategy.

Suggested Citation

  • Bo, Lijun & Tang, Dan & Wang, Yongjin, 2017. "Optimal investment of variance-swaps in jump-diffusion market with regime-switching," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 175-197.
    • Handle: RePEc:eee:dyncon:v:83:y:2017:i:c:p:175-197
    DOI: 10.1016/j.jedc.2017.08.003
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    References listed on IDEAS

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    Cited by:

    1. Ding, Kailin & Ning, Ning, 2021. "Markov chain approximation and measure change for time-inhomogeneous stochastic processes," Applied Mathematics and Computation, Elsevier, vol. 392(C).
    2. Weiyi Liu & Song‐Ping Zhu, 2019. "Pricing variance swaps under the Hawkes jump‐diffusion process," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(6), pages 635-655, June.

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    More about this item

    Keywords

    Jump-diffusion; Regime-switching; Variance swaps; Optimal investment;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D9 - Microeconomics - - Micro-Based Behavioral Economics

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