Skip to Main content Skip to Navigation
Journal articles

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.
Document type :
Journal articles
Complete list of metadata

Cited literature [27 references]  Display  Hide  Download

https://halshs.archives-ouvertes.fr/halshs-00002695
Contributor : Rama Cont Connect in order to contact the contributor
Submitted on : Tuesday, August 24, 2004 - 7:40:49 PM
Last modification on : Wednesday, October 20, 2021 - 12:23:55 AM
Long-term archiving on: : Monday, March 29, 2010 - 9:37:35 PM

Identifiers

Collections

Citation

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

Share

Metrics

Les métriques sont temporairement indisponibles