Following the path initiated by Merton (1973), we study the option pricing problem in an economy with stochastic interest rates. We model the short rate dynamic by a diffusion process whose parameters are modulated by an underlying Markov process with jumps, as in Landen (2000). By exploiting the change of numeraire technique we obtain, under some assumption, a simple and easy to use call pricing formula which we then apply to the evaluation of risky debts so enlarging the flexibility of previous results obtained by Shimko et al. (1993). We also provide a detailed numerical study of call prices and credit spreads for a straightforward but interesting extension of the Vasicek dynamic included in our model.

Ramponi, A., Scarlatti, S. (2009). Option pricing in a hidden Markov model of the short rate with application to risky debt evaluation. INTERNATIONAL JOURNAL OF RISK ASSESSMENT AND MANAGEMENT, 11(1-2), 88-103 [10.1504/IJRAM.2009.022199].

Option pricing in a hidden Markov model of the short rate with application to risky debt evaluation

RAMPONI, ALESSANDRO;SCARLATTI, SERGIO
2009-01-01

Abstract

Following the path initiated by Merton (1973), we study the option pricing problem in an economy with stochastic interest rates. We model the short rate dynamic by a diffusion process whose parameters are modulated by an underlying Markov process with jumps, as in Landen (2000). By exploiting the change of numeraire technique we obtain, under some assumption, a simple and easy to use call pricing formula which we then apply to the evaluation of risky debts so enlarging the flexibility of previous results obtained by Shimko et al. (1993). We also provide a detailed numerical study of call prices and credit spreads for a straightforward but interesting extension of the Vasicek dynamic included in our model.
2009
Pubblicato
Rilevanza internazionale
Articolo
Sì, ma tipo non specificato
Settore SECS-S/06 - METODI MATEMATICI DELL'ECONOMIA E DELLE SCIENZE ATTUARIALI E FINANZIARIE
English
hidden Markov models; option pricing; regime switching models; risky debts; semi-affine term structure; T-forward measures
Ramponi, A., Scarlatti, S. (2009). Option pricing in a hidden Markov model of the short rate with application to risky debt evaluation. INTERNATIONAL JOURNAL OF RISK ASSESSMENT AND MANAGEMENT, 11(1-2), 88-103 [10.1504/IJRAM.2009.022199].
Ramponi, A; Scarlatti, S
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/2108/14783
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