Incorporating statistical model error into the calculation of acceptability prices of contingent claims

Martin Glanzer, Georg Ch. Pflug and Alois Pichler

Papers from arXiv.org

Abstract: The determination of acceptability prices of contingent claims requires the choice of a stochastic model for the underlying asset price dynamics. Given this model, optimal bid and ask prices can be found by stochastic optimization. However, the model for the underlying asset price process is typically based on data and found by a statistical estimation procedure. We define a confidence set of possible estimated models by a nonparametric neighborhood of a baseline model. This neighborhood serves as ambiguity set for a multi-stage stochastic optimization problem under model uncertainty. We obtain distributionally robust solutions of the acceptability pricing problem and derive the dual problem formulation. Moreover, we prove a general large deviations result for the nested distance, which allows to relate the bid and ask prices under model ambiguity to the quality of the observed data.

Date: 2017-03, Revised 2019-01
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (3)

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