Hedging with Small Uncertainty Aversion

Sebastian Herrmann, Johannes Muhle-Karbe and Frank Thomas Seifried
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Sebastian Herrmann: University of Michigan at Ann Arbor
Johannes Muhle-Karbe: Imperial College London - Department of Mathematics
Frank Thomas Seifried: University of Trier

No 15-19, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: 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.

Keywords: volatility uncertainty; ambiguity aversion; option pricing and hedging; asymptotics (search for similar items in EconPapers)
JEL-codes: C61 C73 G13 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2015-07, Revised 2017-04
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Citations: View citations in EconPapers (13)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1519

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