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American Options With Regime Switching

Author

Listed:
  • JOHN BUFFINGTON

    (Deloitte & Touche LLP, Suite 230, 333 Clay St., Houston, TX, 77002-4196, USA)

  • ROBERT J. ELLIOTT

    (Faculty of Management, University of Calgary, Calgary, 2500 University Drive NW, Calgary, Alberta, Canada T2N 1N4, Canada)

Abstract

A Black-Scholes market is considered in which the underlying economy, as modeled by the parameters and volatility of the processes, switches between a finite number of states. The switching is modeled by a hidden Markov chain. European options are priced and a Black-Scholes equation obtained. The approximate valuation of American options due to Barone-Adesi and Whaley is extended to this setting.

Suggested Citation

  • 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.
    • Handle: RePEc:wsi:ijtafx:v:05:y:2002:i:05:n:s0219024902001523
    DOI: 10.1142/S0219024902001523
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