Simple and Good - Option Pricing with Regime Switching Skew Tree Models

Abstract

This article provides a contribution to the search for a stochastic model to describe the evolution of the prices of stocks and similar variables that matches the option prices observable on the market and their dynamics. Part 1 covers the design of a system of regime swiching tree models, which allows to generate a large variety of implied volatility surfaces with high regularity of the stochastic process of the underlying. Part 2 examines how well a very simple one of these models allows to represent Eurex DAX option prices at the time of the Brexit vote in 2016 as well as the French presidential election in 2017.