NUMERICAL SCHEMES FOR OPTION PRICING IN REGIME-SWITCHING JUMP DIFFUSION MODELS

In this paper, we present algorithms to solve a complex system of partial integro-differential equations (PIDE's) of parabolic type. The system is motivated by applications in finance where the solution of the system gives the price of European options in a regime-switching jump diffusion model...

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Bibliographic Details
Published in:International journal of theoretical and applied finance 2013-12, Vol.16 (8), p.1350046-1350046
Main Authors: FLORESCU, IONUT, LIU, RUIHUA, MARIANI, MARIA CRISTINA, SEWELL, GRANVILLE
Format: Article
Language:English
Subjects:
Algorithms
Econometric models
Europe
Markovian processes
Option pricing
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Summary:In this paper, we present algorithms to solve a complex system of partial integro-differential equations (PIDE's) of parabolic type. The system is motivated by applications in finance where the solution of the system gives the price of European options in a regime-switching jump diffusion model. The new algorithms are based on theoretical analysis in Florescu et al. (2012) where the proof of convergence of the algorithms is carried out. The problems are also solved using a more traditional approach, where the integral terms (but not the derivative terms) are treated explicitly. Another contribution of this work details a novel type of jump distribution. Empirical evidence suggests that this type of distribution may be more appropriate to model jumps as it makes them more clearly distinguishable from the signal variability.
ISSN:0219-0249
1793-6322
DOI:10.1142/S0219024913500465