Applying hedging strategies to estimate model risk and provision calculation

Alberto Elices and Eduard Gim\'enez

Papers from arXiv.org

Abstract: This paper introduces a relative model risk measure of a product priced with a given model, with respect to another reference model for which the market is assumed to be driven. This measure allows comparing products valued with different models (pricing hypothesis) under a homogeneous framework which allows concluding which model is the closest to the reference. The relative model risk measure is defined as the expected shortfall of the hedging strategy at a given time horizon for a chosen significance level. The reference model has been chosen to be Heston calibrated to market for a given time horizon (this reference model should be chosen to be a market proxy). The method is applied to estimate and compare this relative model risk measure under volga-vanna and Black-Scholes models for double-no-touch options and a portfolio of forward fader options.

Date: 2011-02, Revised 2012-10
New Economics Papers: this item is included in nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1102.3534

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