Are regime-shift sources of risk priced in the market?

• Published in: Journal of empirical finance Vol. 28; pp. 151 - 170
• Main Authors: Chourdakis, Kyriakos, Dendramis, Yiannis, Tzavalis, Elias
• Format: Journal Article
• Language: English
• Published: Elsevier B.V 01.09.2014
• Subjects: Error; Europe; European call prices; Market; Markov regime switching model; Markovian processes; Occupation time; Pricing; Probability; Risk; Risk neutral transition probabilities; Stock market regime shifts; Volatility; European call prices; G10; G13; Stock market regime shifts; G12; Markov regime switching model; Occupation time; Risk neutral transition probabilities

In this paper we develop a discrete-time pricing model for European options where the log-return of the underlying asset is subject to discontinuous regime shifts in its mean and/or volatility which follow a Markov chain. The model allows for multiple regime shifts whose risk cannot be hedge out and...