Price dynamics under stochastic process switching: some extensions and an application to EMU

In this paper we solve a particular type of stochastic process switching pr oblem where the date of switching is fixed and known but the terminal price may depend on past prices. We derive closed-form solutions for the price d ynamics of the asset before the terminal date and deduce the variance and j ump components of these dynamics at the announcement. We subsequently exten d the model to price dynamics prior to the announcement of the regime switc h assuming that markets may have some expectations regarding the occurrence and/or the type of the regime switch. Finally, we apply the general model to discuss the implications of the chosen conversion modalities in the Euro pean Monetary Union (EMU) conversion procedure. (C) 1999 Elsevier Science L td. All rights reserved.