Measures of Model Risk for Continuous-Time Finance Models*

Emese Lazar, Shuyuan Qi and Radu Tunaru

Journal of Financial Econometrics, 2024, vol. 22, issue 5, 1456-1481

Abstract: Measuring model risk is required by regulators in financial and insurance markets. We separate model risk into parameter estimation risk (PER) and model specification risk (MSR), and we propose expected shortfall type model risk measures applied to Lévy jump, affine jump-diffusion, and multifactor models. We investigate the impact of PER and MSR on the models’ ability to capture the joint dynamics of stock and option prices. Using Markov chain Monte Carlo techniques, we implement two methodologies to estimate parameters under the risk-neutral probability measure and the real-world probability measure jointly.

Keywords: Lévy models; MCMC; model specification risk; parameter estimation risk; stochastic volatility (search for similar items in EconPapers)
JEL-codes: C11 C52 G12 G13 (search for similar items in EconPapers)
Date: 2024
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