Pricing Options and Equity-Indexed Annuities in a Regime-switching Model by Trinomial Tree Method

• Published in: Journal of Systemics, Cybernetics and Informatics
• Main Authors: Fei Lung Yuen, Hailiang Yang
• Format: Article
• Language: English
• Published: International Institute of Informatics and Cybernetics 2011-12-01
• Subjects: Path Dependent Options; Trinomial Tree Method; Regime Switching Model; Option Pricing; Equity-Indexed Annuity
• Online Access: http://www.iiisci.org/Journal/CV$/sci/pdfs/RO130IV.pdf

In this paper we summarize the main idea and results of Yuen and Yang (2009, 2010a, 2010b) and provide some results on pricing of Parisian options under the Markov regime-switching model (MRSM). The MRSM allows the parameters of the market model depending on a Markovian process, and the model can reflect the information of the market environment which cannot be modeled solely by linear Gaussian process. However, when the parameters of the stock price model are not constant but governed by a Markovian process, the pricing of the options becomes complex. We present a fast and simple trinomial tree model to price options in MRSM. In recent years, the pricing of modern insurance products, such as Equity-Indexed annuity (EIA) and variable annuities (VAs), has become a popular topic. We show here that our trinomial tree model can been used to price EIA with strong path dependent exotic options in the regime switching model.