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Discounted Optimal Stopping Problems for Maxima of Geometric Brownian Motions With Switching Payoffs
Published online by Cambridge University Press: 17 March 2021
Abstract
We present closed-form solutions to some discounted optimal stopping problems for the running maximum of a geometric Brownian motion with payoffs switching according to the dynamics of a continuous-time Markov chain with two states. The proof is based on the reduction of the original problems to the equivalent free-boundary problems and the solution of the latter problems by means of the smooth-fit and normal-reflection conditions. We show that the optimal stopping boundaries are determined as the maximal solutions of the associated two-dimensional systems of first-order nonlinear ordinary differential equations. The obtained results are related to the valuation of real switching lookback options with fixed and floating sunk costs in the Black–Merton–Scholes model.
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- © The Author(s), 2021. Published by Cambridge University Press on behalf of Applied Probability Trust
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