Locally Constant Model Uncertainty Risk Measure

Lazar Obradovic
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Lazar Obradovic: Center for Mathematical Economics, Bielefeld University

No 609, Center for Mathematical Economics Working Papers from Center for Mathematical Economics, Bielefeld University

Abstract: This paper introduces a (coherent) risk measure that describes the uncertainty of the model (represented by a probability measure $P_0$) by a set $P_\lambda$ of probability measures each of which has a Radon-Nikodym's derivative (with respect to $P_0$) that lies within the interval $[\lambda,\frac{1}{\lambda}]$ for some constant $\lambda\in(0,1]$. Economic considerations are discussed and an explicit representation is obtained that gives a connection to both the expected loss of the financial position and its *average value-at-risk*. Optimal portfolio analysis is performed -- different optimization criteria lead to Merton portfolio. Comparison with related problems reveals examples of extreme sensitivity of optimal portfolios to model parameters and the choice of risk measure.

Keywords: Risk measure; Model uncertainty; Value at risk; Average value at risk; Optimal portfolio; Merton portfolio. (search for similar items in EconPapers)
Date: 2019-02-13
New Economics Papers: this item is included in nep-rmg
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https://pub.uni-bielefeld.de/download/2933748/2933749 First Version, 2019 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:bie:wpaper:609

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