A new exact solution for pricing European options in a two-state regime-switching economy. (English) Zbl 1268.91170

Summary: We derive a new exact solution for pricing European options in a two-state regime-switching economy. Two coupled Black-Scholes partial differential equations (PDEs) under the regime switching are solved using the Fourier Transform method. A key feature of the newly-derived solution is its simplicity in the form of a single integral with a real integrand, which leads to great computational efficiency in comparison with other closed-form solutions previously presented in the literature. Numerical examples are provided to demonstrate some interesting results obtained from our pricing formula.


91G20 Derivative securities (option pricing, hedging, etc.)
35Q91 PDEs in connection with game theory, economics, social and behavioral sciences
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