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Article

A Discrete-Time Approach to Evaluate Path-Dependent Derivatives in a Regime-Switching Risk Model

Department of Economics, Statistics and Finance, University of Calabria, Ponte Bucci cubo 1C, 87036 Rende (CS), Italy
Received: 29 November 2019 / Revised: 24 January 2020 / Accepted: 25 January 2020 / Published: 29 January 2020
(This article belongs to the Special Issue Model Risk and Risk Measures)
This paper provides a discrete-time approach for evaluating financial and actuarial products characterized by path-dependent features in a regime-switching risk model. In each regime, a binomial discretization of the asset value is obtained by modifying the parameters used to generate the lattice in the highest-volatility regime, thus allowing a simultaneous asset description in all the regimes. The path-dependent feature is treated by computing representative values of the path-dependent function on a fixed number of effective trajectories reaching each lattice node. The prices of the analyzed products are calculated as the expected values of their payoffs registered over the lattice branches, invoking a quadratic interpolation technique if the regime changes, and capturing the switches among regimes by using a transition probability matrix. Some numerical applications are provided to support the model, which is also useful to accurately capture the market risk concerning path-dependent financial and actuarial instruments. View Full-Text
Keywords: regime-switching risk; market risk; path-dependent derivatives; insurance policies; binomial lattices; discrete-time models regime-switching risk; market risk; path-dependent derivatives; insurance policies; binomial lattices; discrete-time models
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MDPI and ACS Style

Russo, E. A Discrete-Time Approach to Evaluate Path-Dependent Derivatives in a Regime-Switching Risk Model. Risks 2020, 8, 9. https://doi.org/10.3390/risks8010009

AMA Style

Russo E. A Discrete-Time Approach to Evaluate Path-Dependent Derivatives in a Regime-Switching Risk Model. Risks. 2020; 8(1):9. https://doi.org/10.3390/risks8010009

Chicago/Turabian Style

Russo, Emilio. 2020. "A Discrete-Time Approach to Evaluate Path-Dependent Derivatives in a Regime-Switching Risk Model" Risks 8, no. 1: 9. https://doi.org/10.3390/risks8010009

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