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Option Pricing With A Levy-Type Stochastic Dynamic Model For Stock Price Process Under Semi-Markovian Structural Perturbations

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  • PATRICK ASSONKEN

    (Mathematics and Statistics, University of South Florida, 4202 East Fowler Avenue, Tampa, Florida 33613, USA)

  • G. S. LADDE

    (Mathematics and Statistics, University of South Florida, 4202 East Fowler Avenue, Tampa, Florida 33613, USA)

Abstract

In this work, we consider a stock price process subjected to idiosyncratic Lévy jumps and global structural changes attributed to interventions due to a semi-Markov process. The semi-Markov process decomposes both the time and state domains of the price process into sub-intervals and price state sub-domains respectively, where a Lévy–Ito process operates. The Lévy jumps decompose the space domain of the currently operating Lévy process. We derive an infinitesimal generator for a stock price process and a closed form expression for the conditional characteristic function of a log price. The former result is used to derive a PIDE satisfied by option prices, while the latter could be used to retrieve risk neutral densities via Fourier transform and price European vanilla options. In the sequel, we derive the characteristic function of the residence time of a semi-Markov process. Incompleteness of the market is exhibited through a general change of measure. For pricing purpose, the minimum entropy martingale measure is defined as an Esscher transform.

Suggested Citation

  • Patrick Assonken & G. S. Ladde, 2015. "Option Pricing With A Levy-Type Stochastic Dynamic Model For Stock Price Process Under Semi-Markovian Structural Perturbations," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 18(08), pages 1-72, December.
    • Handle: RePEc:wsi:ijtafx:v:18:y:2015:i:08:n:s0219024915500521
    DOI: 10.1142/S0219024915500521
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    1. Patrick Assonken & Gangaram Ladde, 2017. "Simulation and Calibration of Options Prices under a Levy-Type Stochastic Dynamic and Semi Markov Market Switching Regimes Processes," Applied Economics and Finance, Redfame publishing, vol. 4(1), pages 93-126, January.

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