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On a continuous time stock price model with regime switching, delay, and threshold

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  • Pedro P. Mota
  • Manuel L. Esqu�vel

Abstract

Motivated by the need to describe bear-bull market regime switching in stock prices, we introduce and study a stochastic process in continuous time with two regimes, threshold and delay, given by a stochastic differential equation. When the difference between the regimes is simply given by a different set of real valued parameters for the drift and diffusion coefficients, with changes between regimes depending only on these parameters, we show that if the delay is known there are consistent estimators for the threshold as long we know how to classify a given observation of the process as belonging to one of the two regimes. When the drift and diffusion coefficients are of geometric Brownian motion type we obtain a model with parameters that can be estimated in a satisfactory way, a model that allows differentiating regimes in some of the NYSE 21 stocks analyzed and also, that gives very satisfactory results when compared to the usual Black-Scholes model for pricing call options.

Suggested Citation

  • Pedro P. Mota & Manuel L. Esqu�vel, 2013. "On a continuous time stock price model with regime switching, delay, and threshold," Quantitative Finance, Taylor & Francis Journals, vol. 14(8), pages 1479-1488, December.
    • Handle: RePEc:taf:quantf:v:14:y:2013:i:8:p:1479-1488
    DOI: 10.1080/14697688.2013.879990
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    References listed on IDEAS

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    1. Asbjørn T. Hansen & Rolf Poulsen, 2000. "A simple regime switching term structure model," Finance and Stochastics, Springer, vol. 4(4), pages 409-429.
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