Prior Specification for Multivariate Regime-Switching Asset Simulations

• Activity Number: 532
• Type: Contributed
• Date/Time: Wednesday, August 12, 2015 : 10:30 AM to 12:20 PM
• Sponsor: Business and Economic Statistics Section
• Author(s): Brian Hartman* and David Engler and Chris Groendyke
• Companies: Brigham Young University and Brigham Young University and Robert Morris University
• Keywords: Hidden Markov ; Label-switching ; Risk Management

Abstract

Writers of insurance guarantees have increasingly sought pricing improvement through model complexity. However, complex options often have no closed-form pricing solution and guarantees must be priced through stochastic simulation of the underlying asset. Regime-switching models are an intuitive way to incorporate stochastic volatility into the simulated asset price and have been shown to accurately model single asset streams (e.g., stock index data). Many guarantees, however, are based on multiple assets. Ignoring between-asset correlation can expose the writer to significant pricing risk. We develop a multivariate regime-switching model and compare different prior specifications for the between-asset correlations.