Optimal switching decisions under stochastic volatility with fast mean reversion

• Published in: European journal of operational research Vol. 251; no. 1; pp. 148 - 157
• Main Authors: Tsekrekos, Andrianos E., Yannacopoulos, Athanasios N.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 16-05-2016; Elsevier Sequoia S.A
• Subjects: Approximation; Decision analysis; Flexibility; Hysteresis; Inequalities; Mathematical analysis; Mathematical problems; Multi-scale stochastic volatility; Operations research; Optimal switching problems; Optimization; Quasi-variational inequalities; Stochastic models; Stochasticity; Studies; Switching; Volatility; Optimal switching problems; Multi-scale stochastic volatility; Hysteresis; Quasi-variational inequalities
• ISSN: 0377-2217; 1872-6860
• DOI: 10.1016/j.ejor.2015.12.011

•Study optimal switching problems under “fast” mean-reverting stochastic volatility.•Derive closed-form approximations of the full problem via homogenization theory.•Apply our general solution to well-known switching problems and volatility models.•Proposed method is of interest to applied problems involving switching flexibility.
We study infinite-horizon, optimal switching problems for underlying processes that exhibiting “fast” mean-reverting stochastic volatility. We obtain closed-form analytic approximations of the solution for the resulting quasi-variational inequalities, that provide quantitative and qualitative results for the effects of multi-scale variability of the underlying process on the optimal switching rule. The proposed methodology is applicable to a number of operations research problems involving switching flexibility.