Group for Research in Decision Analysis


Analytical valuation of compound options under regime switching dynamics


We propose an analytical formula for the evaluation of compound options when the underlying asset is described by a two-states Markov regime-switching log-normal model. One specific application of interest of such a formula is the pricing of principal protected callable notes with an early redemption feature. This approach provides practitioners with a Black-Scholes-type formula under a realistic assumption about market prices behavior.

, 13 pages