Market Risk and Model Risk for a Financial Institution Writing Options
Derivatives valuation and risk management involve heavy use of quantitative models. To develop a quantitative assessment of model risk as it affects the basic option writing strategy that might be followed by a financial institution, we conduct an empirical simulation, with and without hedging, using data from 1976 to 1996. Results indicate that imperfect models and inaccurate volatility forecasts create sizable risk exposure for option writers. We consider to what extent the damage due to model risk can be limited by pricing options using a higher volatility than the best estimate from historical data. Copyright The American Finance Association 1999.
Year of publication: |
1999
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Authors: | Green, T. Clifton ; Figlewski, Stephen |
Published in: |
Journal of Finance. - American Finance Association - AFA, ISSN 1540-6261. - Vol. 54.1999, 4, p. 1465-1499
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Publisher: |
American Finance Association - AFA |
Saved in:
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