Model Uncertainty, Recalibration, and the Emergence of Delta-Vega Hedging
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Date
2016-01-04
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Working Paper
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Abstract
We study option pricing and hedging with uncertainty about a Black-Scholes reference model which is dynamically recalibrated to the market price of a liquidly traded vanilla option. For dynamic trading in the underlying asset and this vanilla option, delta-vega hedging is asymptotically optimal in the limit for small uncertainty aversion. The corresponding indifference price corrections are determined by the disparity between the vegas, gammas, vannas, and volgas of the non-traded and the liquidly traded options.
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published
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Volume
15 (52)
Pages / Article No.
Publisher
University of Geneva
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Subject
Model uncertainty; Recalibration; Delta-vega hedging; Small uncertainty aversion; Asymptotics
Organisational unit
03658 - Schweizer, Martin / Schweizer, Martin
03899 - Muhle-Karbe, Johannes (ehemalig)
Notes
Published online 24 November 2015.