Model Uncertainty, Recalibration, and the Emergence of Delta-Vega Hedging
Copyright policy )Model Uncertainty, Recalibration, and the Emergence of Delta-Vega Hedging
We study option pricing and hedging with uncertainty about a Black-Scholes reference model which is dynamically recalibrated to the market price of a liquidly traded vanilla option. For dynamic trading in the underlying asset and this vanilla option, delta-vega hedging is asymptotically optimal in the limit for small uncertainty aversion. The corresponding indifference price corrections are determined by the disparity between the vegas, gammas, vannas, and volgas of the non-traded and the liquidly traded options.
44 pages; forthcoming in 'Finance and Stochastics'
- University of Michigan–Ann Arbor United States
- Imperial College London United Kingdom
- University of Manchester United Kingdom
- University of Manchester United Kingdom
- University of Manchester United Kingdom
dynamically recalibrated implied volatility, Hamilton-Jacobi-Bellman-Isaacs equation, Black-Scholes model, Mathematical Finance (q-fin.MF), FOS: Economics and business, Stochastic games, stochastic differential games, self-financing strategy, Derivative securities (option pricing, hedging, etc.), Quantitative Finance - Mathematical Finance, Optimization and Control (math.OC), FOS: Mathematics, Optimal stochastic control, model uncertainty, stochastic differential game, delta-vega hedging, Utility theory, Mathematics - Optimization and Control
dynamically recalibrated implied volatility, Hamilton-Jacobi-Bellman-Isaacs equation, Black-Scholes model, Mathematical Finance (q-fin.MF), FOS: Economics and business, Stochastic games, stochastic differential games, self-financing strategy, Derivative securities (option pricing, hedging, etc.), Quantitative Finance - Mathematical Finance, Optimization and Control (math.OC), FOS: Mathematics, Optimal stochastic control, model uncertainty, stochastic differential game, delta-vega hedging, Utility theory, Mathematics - Optimization and Control
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