Model uncertainty and its impact on the pricing of derivative instruments - HAL-SHS - Sciences de l'Homme et de la Société Access content directly
Journal Articles Mathematical Finance Year : 2006

Model uncertainty and its impact on the pricing of derivative instruments

Abstract

Model uncertainty, in the context of derivative pricing, can be defined as the uncertainty on the value of a contingent claim resulting from the lack of precise knowledge of the pricing model to be used for its valuation. We introduce here a quantitative framework for defining model uncertainty in option pricing models. After discussing some properties which a quantitative measure of model uncertainty should verify in order to be useful and relevant in the context of risk measurement and management, we propose a method for measuring model uncertainty which verifies these properties and yields numbers which are comparable to other risk measures and compatible with observations of market prices of a set of benchmark derivatives. We illustrate the difference between model uncertainty and the more common notion of "market risk" through examples. Finally, we illustrate the connection between our proposed measure of model uncertainty and the recent literature on coherent and convex risk measures.
Fichier principal
Vignette du fichier
ModelRisk.pdf (705.27 Ko) Télécharger le fichier
Loading...

Dates and versions

halshs-00002695 , version 1 (24-08-2004)

Identifiers

Cite

Rama Cont. Model uncertainty and its impact on the pricing of derivative instruments. Mathematical Finance, 2006, 16 (3), pp.519 - 547. ⟨10.1111/j.1467-9965.2006.00281.x⟩. ⟨halshs-00002695⟩
301 View
2252 Download

Altmetric

Share

Gmail Facebook X LinkedIn More