Implications of parameter uncertainty on option prices
Lindström, Erik LU
(2010)
In Advances in Decision Sciences
2010.
p.1-15
- Abstract
- Financial markets are complex processes where investors interact
to set prices. We present a framework for option valuation under imperfect
information, taking risk neutral parameter uncertainty into account. The
framework is a direct generalization of the existing valuation methodology.
Many investors base their decisions on mathematical models that have been
calibrated to market prices. We argue that the calibration process introduces
a source of uncertainty that needs to be taken into account. The models
and parameters used may differ to such extent that one investor may find an
option under-priced whereas another investor may find the very same option
... (More) - Financial markets are complex processes where investors interact
to set prices. We present a framework for option valuation under imperfect
information, taking risk neutral parameter uncertainty into account. The
framework is a direct generalization of the existing valuation methodology.
Many investors base their decisions on mathematical models that have been
calibrated to market prices. We argue that the calibration process introduces
a source of uncertainty that needs to be taken into account. The models
and parameters used may differ to such extent that one investor may find an
option under-priced whereas another investor may find the very same option
over-priced. This problem is not taken into account by any of the standard
models.
The paper is concluded by presenting simulations and an empirical study
on FX options where we demonstrate improved predictive performance (in
sample and out of sample) using this framework. (Less)
Please use this url to cite or link to this publication:
https://lup.lub.lu.se/record/1546401
- author
- Lindström, Erik
LU
- organization
- publishing date
- 2010
- type
- Contribution to journal
- publication status
- published
- subject
- in
- Advances in Decision Sciences
- volume
- 2010
- pages
- 1 - 15
- publisher
- Hindawi Limited
- external identifiers
-
- scopus:80051606293
- ISSN
- 2090-3359
- DOI
- 10.1155/2010/598103
- language
- English
- LU publication?
- yes
- additional info
- http://www.hindawi.com/journals/ads/ Föregående titel: Journal of Applied Mathematics and Decision Sciences
- id
- b128b0ea-69c2-4c08-bc12-a4349ecc9087 (old id 1546401)
- date added to LUP
- 2016-04-01 09:54:09
- date last changed
- 2022-02-17 04:43:30
@article{b128b0ea-69c2-4c08-bc12-a4349ecc9087,
abstract = {{Financial markets are complex processes where investors interact<br/><br>
to set prices. We present a framework for option valuation under imperfect<br/><br>
information, taking risk neutral parameter uncertainty into account. The<br/><br>
framework is a direct generalization of the existing valuation methodology.<br/><br>
Many investors base their decisions on mathematical models that have been<br/><br>
calibrated to market prices. We argue that the calibration process introduces<br/><br>
a source of uncertainty that needs to be taken into account. The models<br/><br>
and parameters used may differ to such extent that one investor may find an<br/><br>
option under-priced whereas another investor may find the very same option<br/><br>
over-priced. This problem is not taken into account by any of the standard<br/><br>
models.<br/><br>
The paper is concluded by presenting simulations and an empirical study<br/><br>
on FX options where we demonstrate improved predictive performance (in<br/><br>
sample and out of sample) using this framework.}},
author = {{Lindström, Erik}},
issn = {{2090-3359}},
language = {{eng}},
pages = {{1--15}},
publisher = {{Hindawi Limited}},
series = {{Advances in Decision Sciences}},
title = {{Implications of parameter uncertainty on option prices}},
url = {{http://dx.doi.org/10.1155/2010/598103}},
doi = {{10.1155/2010/598103}},
volume = {{2010}},
year = {{2010}},
}