On pricing and hedging options in regime-switching models with feedback effect
Product price kernel
SubjectPricing and hedging
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AbstractWe study the pricing and hedging of European-style derivative securities in a Markov, regime-switching, model with a feedback e ect depending on the economic condition. We adopt a pricing kernel which prices both nancial and economic risks explicitly in a dynamically incomplete market and we provide an equilibrium analysis. A martingale representation for a European-style index option's price is established based on the price kernel. The martingale representation is then used to construct the local risk-minimizing strategy explicitly and to characterize the corresponding pricing measure.
Article deposited according to publisher policy posted on SHERPA/ROMEO, June 13, 2012.