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Assessing the costs of protection in a context of switching stochastic regimes

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  • Barrieu, Pauline
  • Bellamy, Nadine
  • Sahut, Jean-Michel

Abstract

We consider the problem of cost assessment in the context of switching stochastic regimes. The dynamics of a given asset include a background noise, described by a Brownian motion and a random shock, the impact of which is characterized by changes in the coefficient diffusions. A particular economic agent that is directly exposed to variations in the underlying asset price, incurs some costs, , when the underlying asset price reaches a certain threshold, L. Ideally, the agent would make advance provision, or hedge, for these costs at time 0. We evaluate the amount of provision, or the hedging premium, , for these costs in the disrupted environment, with changes in the regime for a given time horizon, and analyse the sensitivity of this amount to possible model misspecifications.

Suggested Citation

  • Barrieu, Pauline & Bellamy, Nadine & Sahut, Jean-Michel, 2012. "Assessing the costs of protection in a context of switching stochastic regimes," LSE Research Online Documents on Economics 42431, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:42431
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    References listed on IDEAS

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    More about this item

    Keywords

    provision; hedging; costs assessment; stochastic regimes;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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