An exact and explicit formula for pricing Asian options with regime switching

TL;DR

This paper derives exact, explicit formulas for pricing European Asian options in a regime-switching model where asset dynamics depend on an unobservable Markov process, advancing option pricing theory under complex market conditions.

Contribution

It provides the first closed-form solutions for Asian options in a two-state regime switching model, incorporating unobservable economic states.

Findings

Derived explicit formulas for Asian options under regime switching.

Closed-form solutions facilitate efficient pricing in complex market models.

Enhances understanding of option pricing with regime-dependent asset dynamics.

Abstract

This paper studies the pricing of European-style Asian options when the price dynamics of the underlying risky asset are assumed to follow a Markov- modulated geometric Brownian motion; that is, the appreciation rate and the volatility of the underlying risky asset depend on unobservable states of the economy described by a continuous-time hidden Markov process. We derive the exact, explicit and closed-form solutions for European-style Asian options in a two-state regime switching model.