Hedging with Small Uncertainty Aversion
Copyright policy )Hedging with Small Uncertainty Aversion
We study the pricing and hedging of derivative securities with uncertainty about the volatility of the underlying asset. Rather than taking all models from a prespecified class equally seriously, we penalise less plausible ones based on their "distance" to a reference local volatility model. In the limit for small uncertainty aversion, this leads to explicit formulas for prices and hedging strategies in terms of the security's cash gamma.
48 pages; forthcoming in 'Finance and Stochastics'
- Imperial College London United Kingdom
- University of Manchester United Kingdom
- University of Manchester United Kingdom
- University of Manchester United Kingdom
- University of Michigan–Ann Arbor United States
ambiguity aversion, Probability (math.PR), volatility uncertainty, option pricing and hedging, Mathematical Finance (q-fin.MF), FOS: Economics and business, Derivative securities (option pricing, hedging, etc.), asymptotics, Quantitative Finance - Mathematical Finance, Optimization and Control (math.OC), FOS: Mathematics, Optimal stochastic control, Utility theory, Mathematics - Optimization and Control, Mathematics - Probability
ambiguity aversion, Probability (math.PR), volatility uncertainty, option pricing and hedging, Mathematical Finance (q-fin.MF), FOS: Economics and business, Derivative securities (option pricing, hedging, etc.), asymptotics, Quantitative Finance - Mathematical Finance, Optimization and Control (math.OC), FOS: Mathematics, Optimal stochastic control, Utility theory, Mathematics - Optimization and Control, Mathematics - Probability
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