Valuation of correlation options under a stochastic interest rate model with regime switching

Kun Fan; Rongming Wang

doi:10.1007/s11464-017-0608-5

Valuation of correlation options under a stochastic interest rate model with regime switching

Kun Fan
, Rongming Wang^*

^*Corresponding author for this work

School of Statistics

East China Normal University

Research output: Contribution to journal › Article › peer-review

3 Scopus citations

Abstract

We consider the valuation of a correlation option, a two-factor analog of a European call option, under a Hull-White interest rate model with regime switching. More specifically, the model parameters are modulated by an observable, continuous-time, finite-state Markov chain. We obtain an integral pricing formula for the correlation option by adopting the techniques of measure changes and inverse Fourier transform. Numerical analysis, via the fast Fourier transform, is provided to illustrate the practical implementation of our model.

Original language	English
Pages (from-to)	1113-1130
Number of pages	18
Journal	Frontiers of Mathematics in China
Volume	12
Issue number	5
DOIs	https://doi.org/10.1007/s11464-017-0608-5
State	Published - 1 Oct 2017

Keywords

Correlation option
fast Fourier transform (FFT)
forward measure
regime-switching
stochastic interest rate

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10.1007/s11464-017-0608-5

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abstract = "We consider the valuation of a correlation option, a two-factor analog of a European call option, under a Hull-White interest rate model with regime switching. More specifically, the model parameters are modulated by an observable, continuous-time, finite-state Markov chain. We obtain an integral pricing formula for the correlation option by adopting the techniques of measure changes and inverse Fourier transform. Numerical analysis, via the fast Fourier transform, is provided to illustrate the practical implementation of our model.",

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AB - We consider the valuation of a correlation option, a two-factor analog of a European call option, under a Hull-White interest rate model with regime switching. More specifically, the model parameters are modulated by an observable, continuous-time, finite-state Markov chain. We obtain an integral pricing formula for the correlation option by adopting the techniques of measure changes and inverse Fourier transform. Numerical analysis, via the fast Fourier transform, is provided to illustrate the practical implementation of our model.

KW - Correlation option

KW - fast Fourier transform (FFT)

KW - forward measure

KW - regime-switching

KW - stochastic interest rate

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JF - Frontiers of Mathematics in China

IS - 5

ER -

Valuation of correlation options under a stochastic interest rate model with regime switching

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Keywords

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