Cost-efficient Payoffs under Model Ambiguity

Carole Bernard, Gero Junike, Thibaut Lux and Steven Vanduffel ()

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Abstract: Dybvig (1988a,b) solves in a complete market setting the problem of finding a payoff that is cheapest possible in reaching a given target distribution ("cost-efficient payoff"). In the presence of ambiguity, the distribution of a payoff is, however, no longer known with certainty. We study the problem of finding the cheapest possible payoff whose worst-case distribution stochastically dominates a given target distribution ("robust cost-efficient payoff") and determine solutions under certain conditions. We study the link between "robust cost-efficiency" and the maxmin expected utility setting of Gilboa and Schmeidler, as well as more generally with robust preferences in a possibly non-expected utility setting. Specifically, we show that solutions to maxmin robust expected utility are necessarily robust cost-efficient. We illustrate our study with examples involving uncertainty both on the drift and on the volatility of the risky asset.

Date: 2022-07, Revised 2023-08
New Economics Papers: this item is included in nep-upt
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Journal Article: Cost-efficient payoffs under model ambiguity (2024)
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