November 1, 2000
This paper derives a general equilibrium option pricing model for a European call assuming that the economy is exogenously driven by a dividend process following Hamilton's (1989) Markov regime switching model. The derived formula is used to investigate if the European call option prices are consistently priced with the stock market prices. This is done by obtaining the implied risk aversion coefficient of the model, for constant relative risk aversion preferences, based on traded option prices data.
J.E.L classification codes: G12, G13, C22, C52
Keywords:Markov regime switching, Option pricing, Risk aversion, Volatility smile