Model uncertainty and the pricing of American options

David Hobson () and Anthony Neuberger ()
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David Hobson: University of Warwick
Anthony Neuberger: City University

Finance and Stochastics, 2017, vol. 21, issue 1, No 8, 285-329

Abstract: Abstract The virtue of an American option is that it can be exercised at any time. This right is particularly valuable when there is model uncertainty. Yet almost all the extensive literature on American options assumes away model uncertainty. This paper quantifies the potential value of this flexibility by identifying the supremum on the price of an American option when we do not impose a model, but rather consider the class of all models which are consistent with a family of European call prices. The bound is enforced by a hedging strategy involving these call options which is robust to model error.

Keywords: American option; Model-free pricing; Robust hedging; Model risk; Rational bounds; 91G20; 91B24 (search for similar items in EconPapers)
JEL-codes: C61 G13 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (6)

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DOI: 10.1007/s00780-016-0314-2

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