Markov-modulated Affine Processes

Publication: Working/Discussion PaperWorking Paper/Preprint

Abstract

We study Markov-modulated affine processes (abbreviated MMAPs), a class of Markov processes that are created from affine processes by allowing some of their coefficients to be a function of an exogenous Markov process. MMAPs allow for richer models in various applications. At the same time MMAPs largely preserve the tractability of standard affine processes, as their characteristic function has a computationally convenient functional form. Our setup is a substantial generalization of earlier work, since we consider the case where the generator of the exogenous process X is an unbounded operator (as is the case for diffusions or jump processes with infinite activity). We prove existence of MMAPs via a martingale problem approach, we derive the formula for their characteristic function and we study various mathematical properties of MMAPs. The paper closes with a discussion of several applications of MMAPs in finance.
Original languageEnglish
Publication statusPublished - 2021

Austrian Classification of Fields of Science and Technology (ÖFOS)

  • 101007 Financial mathematics
  • 101019 Stochastics

Cite this