Rainbow Options under Bayesian MS-VAR Process

TL;DR

This paper introduces new pricing and hedging techniques for rainbow and lookback options using a Bayesian MS-VAR process, which incorporates economic variables and simplifies previous models.

Contribution

It develops a regime-switching model based on Bayesian MS-VAR that is more practical and economically driven than prior approaches.

Findings

Effective pricing and hedging methods for rainbow options

Model depends on economic variables and is simpler

Applicable to regime-switching financial markets

Abstract

This paper presents pricing and hedging methods for rainbow options and lookback options under Bayesian Markov-Switching Vector Autoregressive (MS--VAR) process. Here we assumed that a regime-switching process is generated by a homogeneous Markov process. An advantage of our model is it depends on economic variables and simple as compared with previous existing papers.