| Title | Implications of parameter uncertainty on option prices |
| Authors | Erik Lindström |
| Alternative Location | http://www.hindawi.com/jour... |
| Publication | Advances in Decision Sciences |
| Year | 2010 |
| Document type | Article |
| Status | Inpress |
| Quality controlled | Yes |
| Language | eng |
| Publisher | Hindawi Publishing Corporation |
| Abstract English | Financial markets are complex processes where investors interact<br> to set prices. We present a framework for option valuation under imperfect<br> information, taking risk neutral parameter uncertainty into account. The<br> framework is a direct generalization of the existing valuation methodology.<br> Many investors base their decisions on mathematical models that have been<br> calibrated to market prices. We argue that the calibration process introduces<br> a source of uncertainty that needs to be taken into account. The models<br> and parameters used may differ to such extent that one investor may find an<br> option under-priced whereas another investor may find the very same option<br> over-priced. This problem is not taken into account by any of the standard<br> models.<br> The paper is concluded by presenting simulations and an empirical study<br> on FX options where we demonstrate improved predictive performance (in<br> sample and out of sample) using this framework. |
| ISBN/ISSN/Other | ISSN: 20903359 |
Questions: webmaster
Last update: 2013-04-11
Centre for Mathematical Sciences, Box 118, SE-22100, Lund. Telefon: +46 46-222 00 00 (vx)