Hedging with Small Uncertainty Aversion
Mathematical Finance
2016-05-23 v1 Optimization and Control
Probability
Abstract
We study the pricing and hedging of derivative securities with uncertainty about the volatility of the underlying asset. Rather than taking all models from a prespecified class equally seriously, we penalise less plausible ones based on their "distance" to a reference local volatility model. In the limit for small uncertainty aversion, this leads to explicit formulas for prices and hedging strategies in terms of the security's cash gamma.
Cite
@article{arxiv.1605.06429,
title = {Hedging with Small Uncertainty Aversion},
author = {Sebastian Herrmann and Johannes Muhle-Karbe and Frank Thomas Seifried},
journal= {arXiv preprint arXiv:1605.06429},
year = {2016}
}
Comments
48 pages; forthcoming in 'Finance and Stochastics'