 Calibration risk for exotic optionsKai Detlefsen and Wolfgang Härdle No 2006-001, SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk Abstract: Option pricing models are calibrated to market data of plain vanillas by minimization of an error functional. From the economic viewpoint, there are several possibilities to measure the error between the market and the model. These different specifications of the error give rise to different sets of calibrated model parameters and the resulting prices of exotic options vary significantly. These price differences often exceed the usual profit margin of exotic options. We provide evidence for this calibration risk in a time series of DAX implied volatility surfaces from April 2003 to March 2004. We analyze in the Heston and in the Bates model factors influencing these price differences of exotic options and finally recommend an error functional. Moreover, we determine the model risk of these two stochastic volatility models for the time series and consider its relation to calibration risk. Keywords: calibration risk; calibration; model risk; Heston model; Bates model; barrier option; cliquet option (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:zbw:sfb649:sfb649dp2006-001 Access Statistics for this paper More papers in SFB 649 Discussion Papers from Humboldt University Berlin, Collaborative Research Center 649: Economic Risk Contact information at EDIRC. |
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