Good Deal Hedging and Valuation under Combined Uncertainty about Drift and Volatility

Dirk Becherer and Klebert Kentia

Papers from arXiv.org

Abstract: We study robust notions of good-deal hedging and valuation under combined uncertainty about the drifts and volatilities of asset prices. Good-deal bounds are determined by a subset of risk-neutral pricing measures such that not only opportunities for arbitrage are excluded but also deals that are too good, by restricting instantaneous Sharpe ratios. A non-dominated multiple priors approach to model uncertainty (ambiguity) leads to worst-case good-deal bounds. Corresponding hedging strategies arise as minimizers of a suitable coherent risk measure. Good-deal bounds and hedges for measurable claims are characterized by solutions to second-order backward stochastic differential equations whose generators are non-convex in the volatility. These hedging strategies are robust with respect to uncertainty in the sense that their tracking errors satisfy a supermartingale property under all a-priori valuation measures, uniformly over all priors.

Date: 2017-04
New Economics Papers: this item is included in nep-rmg and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1704.02505

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