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An investigation of model risk in a market with jumps and stochastic volatility

Guillaume Coqueret () and Bertrand Tavin
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Guillaume Coqueret: MRM - Montpellier Research in Management - UPVM - Université Paul-Valéry - Montpellier 3 - UPVD - Université de Perpignan Via Domitia - Groupe Sup de Co Montpellier (GSCM) - Montpellier Business School - UM - Université de Montpellier
Bertrand Tavin: EM - EMLyon Business School

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Abstract: The aim of this paper is to investigate model risk aspects of variance swaps and forward-start options in a realistic market setup where the underlying asset price process exhibits stochastic volatility and jumps. We devise a general framework in order to provide evidence of the model uncertainty attached to variance swaps and forward-start options. In our study, both variance swaps and forward-start options can be valued by means of analytic methods. We measure model risk using a set of 21 models embedding various dynamics with both continuous and discontinuous sample paths. To conduct our empirical analysis, we work with two major equity indices (S&P 500 and Eurostoxx 50) under different market situations. Our results evaluate model risk between 50 and 200 basis points, with an average value slightly above 100 basis points of the contract notional.

Keywords: Forward-start option; Model risk; Risk management; Robustness and sensitivity analysis; Variance swap (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (12)

Published in European Journal of Operational Research, 2016, 253 (3), pp.648-658. ⟨10.1016/j.ejor.2016.03.018⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-02010659

DOI: 10.1016/j.ejor.2016.03.018

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