Black-Scholes formula for a market in a random environment (Q2737019)

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scientific article; zbMATH DE number 1645090
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Black-Scholes formula for a market in a random environment
scientific article; zbMATH DE number 1645090

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    11 September 2001
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    random evolution processes
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    Feynman-Kac formula
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    Black-Scholes formula
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    European call option
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    (B,S)-market
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    Black-Scholes formula for a market in a random environment (English)
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    A standard model for a securities market is given by an ordinary linear differential and a stochastic linear differential equation describing the riskless (bond) and the risky (stock) assets, respectively, with interest rate \(r>0,\) appreciation rate \(\mu\in R\) and volatility \(\sigma>0\). This market is called (B,S)-securities market. In the present paper it is assumed that the parameters \(r,\) \(\mu\) and \(\sigma\) depend on some (environmental) parameter \(x,\) so the above mentioned equations depend on \(x.\) It is assumed that \(x\) varies in time according to a finite Markov chain \(x(t)\), \(x(0)=x\in X.\) The Markov chain is thus the additional source of randomness (besides the Brownian motion) for the market, and the resulting market is called a (B,S)-market in a random environment or (B,S,\(X)\)-incomplete market. The theory of random evolutions via Itô's type formula is used to obtain a Black-Scholes option price formula for the (B,S,\(X)\)-incomplete market for the European call option.
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