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An Analytic Approach for Pricing American Options with Regime Switching

Author

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  • Leunglung Chan

    (School of Mathematics and Statistics, University of New South Wales, Sydney, NSW 2052, Australia)

  • Song-Ping Zhu

    (School of Mathematics and Applied Statistics, University of Wollongong, Wollongong, NSW 2522, Australia)

Abstract

This paper investigates the American option price in a two-state regime-switching model. The dynamics of underlying are driven by a Markov-modulated Geometric Wiener process. That means the interest rate, the appreciation rate, and the volatility of underlying rely on hidden states of the economy which can be interpreted in terms of Markov chains. By means of the homotopy analysis method, an explicit formula for pricing two-state regime-switching American options is presented.

Suggested Citation

  • Leunglung Chan & Song-Ping Zhu, 2021. "An Analytic Approach for Pricing American Options with Regime Switching," JRFM, MDPI, vol. 14(5), pages 1-20, April.
    • Handle: RePEc:gam:jjrfmx:v:14:y:2021:i:5:p:188-:d:540271
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    References listed on IDEAS

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