@inbook{48dcf888addc418c9e2e6769ec46c0d1,
title = "A regime-switching model for European options",
abstract = "We study the pricing of European-style options, with the rate of return and the volatility of the underlying asset depending on the market mode or regime that switches among a finite number of states. This regime-switching model is formulated as a geometric Brownian motion modulated by a finite-state Markov chain. With a Girsanov-like change of measure, we derive the option price using risk-neutral valuation. We also develop a numerical approach to compute the pricing formula, using a successive approximation scheme with a geometric rate of convergence. Using numerical examples of simple, twoor three-state Markov chain models, we are able to demonstrate the presence of the volatility smile and volatility term structure. {\textcopyright} Springer-Verlag US 2006",
keywords = "Option pricing, Regime switching, Successive approximations, Volatility smile and term structure",
author = "Yao, {David D.} and Qing Zhang and Zhou, {Xun Yu}",
year = "2006",
doi = "10.1007/0-387-33815-2_14",
language = "English",
isbn = "978-0-387-33770-8",
series = "International Series in Operations Research and Management Science",
publisher = "Springer ",
pages = "281--300",
editor = "Yan, {Houmin } and Yin, {George } and Zhang, {Qing }",
booktitle = "Stochastic Processes, Optimization, and Control Theory: Applications in Financial Engineering, Queueing Networks, and Manufacturing Systems",
}