An exact and explicit formula for pricing Asian options with regime switching

Abstract

This paper studies the pricing of European-style Asian options when the price dynamics of the underlying risky asset are assumed to follow a Markov- modulated geometric Brownian motion; that is, the appreciation rate and the volatility of the underlying risky asset depend on unobservable states of the economy described by a continuous-time hidden Markov process. We derive the exact, explicit and closed-form solutions for European-style Asian options in a two-state regime switching model.