Applying hedging strategies to estimate model risk and provision calculation
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.
Cite
@article{arxiv.1102.3534,
title = {Applying hedging strategies to estimate model risk and provision calculation},
author = {Alberto Elices and Eduard Giménez},
journal= {arXiv preprint arXiv:1102.3534},
year = {2015}
}
Comments
32 pages, 9 figures, accepted for publication in Quantitative Finance