Hedging with small uncertainty aversion

Sebastian Herrmann (), Johannes Muhle-Karbe () and Frank Thomas Seifried ()
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Sebastian Herrmann: University of Michigan
Johannes Muhle-Karbe: University of Michigan
Frank Thomas Seifried: Universität Trier

Finance and Stochastics, 2017, vol. 21, issue 1, No 1, 64 pages

Abstract: 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; 91G20; 91B16; 93E20 (search for similar items in EconPapers)
JEL-codes: C61 C73 G13 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (13)

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DOI: 10.1007/s00780-016-0309-z

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