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Option Pricing for Pure Jump Processes with Markov Switching Compensators

Author

Listed:
  • Robert J. Elliott

    (University of Calgary)

  • Carlton-James U. Osakwe

    (University of Calgary)

Abstract

This paper proposes a model for asset prices which is the exponential of a pure jump process with an N-state Markov switching compensator. We argue that such a process has a good chance of capturing all the empirical stylized regularities of stock price dynamics and we provide a closed form representation of its characteristic function. We also provide a parsimonious representation of the (not necessarily unique) risk neutral density and show how to price and hedge a large class of options on assets whose prices follow this process.

Suggested Citation

  • Robert J. Elliott & Carlton-James U. Osakwe, 2006. "Option Pricing for Pure Jump Processes with Markov Switching Compensators," Finance and Stochastics, Springer, vol. 10(2), pages 250-275, April.
    • Handle: RePEc:spr:finsto:v:10:y:2006:i:2:d:10.1007_s00780-006-0004-6
    DOI: 10.1007/s00780-006-0004-6
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    References listed on IDEAS

    as
    1. Dilip B. Madan & Peter P. Carr & Eric C. Chang, 1998. "The Variance Gamma Process and Option Pricing," Review of Finance, European Finance Association, vol. 2(1), pages 79-105.
    2. David B. Colwell & Robert J. Elliott, 1993. "Discontinuous Asset Prices And Non‐Attainable Contingent Claims1," Mathematical Finance, Wiley Blackwell, vol. 3(3), pages 295-308, July.
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    4. Benoit Mandelbrot & Howard M. Taylor, 1967. "On the Distribution of Stock Price Differences," Operations Research, INFORMS, vol. 15(6), pages 1057-1062, December.
    5. John Buffington & Robert J. Elliott, 2002. "American Options With Regime Switching," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 5(05), pages 497-514.
    6. Carrasco, Marine & Florens, Jean-Pierre, 2000. "Generalization Of Gmm To A Continuum Of Moment Conditions," Econometric Theory, Cambridge University Press, vol. 16(6), pages 797-834, December.
    7. Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, vol. 41(1), pages 135-155, January.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Jump process; Markov switching; Compensator; Characteristic function; European options; Hedging;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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