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Regime Switching of Stochastic Volatility Model with VG process

Arthit Intarasit

Abstract


In this paper we propose a modeling for a return of underling asset for financial derivative by introduce an exponential of stochastic volatility with variance gamma jumps model which the regime of underling asset return is switching by a finite-state of hidden Markov model. The proposed model explains empirical behaviors of option prices and asset return in a relatively realistic way of modern financial economics. We construct a risk-neutral measure of proposed model based on Girsanov theorem and we provide a risk-neutral model with respect to the risk-neutral measure and its characteristic function. Finally we derive an European option pricing formula.

Keywords


Stochastic volatility; Levy process; Regime switching; Option pricing.

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