Model uncertainty, recalibration, and the emergence of delta–vega hedging
Sebastian Herrmann () and
Johannes Muhle-Karbe ()
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Sebastian Herrmann: University of Michigan
Johannes Muhle-Karbe: University of Michigan
Finance and Stochastics, 2017, vol. 21, issue 4, 873-930
Abstract We study option pricing and hedging with uncertainty about a Black–Scholes reference model which is dynamically recalibrated to the market price of a liquidly traded vanilla option. For dynamic trading in the underlying asset and this vanilla option, delta–vega hedging is asymptotically optimal in the limit for small uncertainty aversion. The corresponding indifference price corrections are determined by the disparity between the vegas, gammas, vannas and volgas of the non-traded and the liquidly traded options.
Keywords: Model uncertainty; Recalibration; Delta–vega hedging; Small uncertainty aversion; Asymptotics; 91G20; 91B16; 93E20 (search for similar items in EconPapers)
JEL-codes: G13 C61 C73 (search for similar items in EconPapers)
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