Model Uncertainty and Its Impact on the Pricing of Derivative Instruments
- Topics:
- Investment and Capital Markets
- Source:
- Finance Concepts
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Overview: Model uncertainty, in the context of derivative pricing, results in mispricing of contingent claims due to uncertainty on the choice of the pricing models. This paper introduces here a quantitative framework for measuring 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 management of derivative instruments, it proposes two methods for measuring model uncertainty, which verify these properties. It also yields numbers, which are comparable to other risk measures and compatible with observations of market prices of a set of benchmark derivatives.
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Format: PDF | Size: 723KB | Date: Jun 2004 | Pages: 34
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