Quantifying the Differences between the Efficient and Fair Valuation and its Implications

In this study, we investigate the relationship between efficient hedging and fair valuation. We find that efficient hedging does not always lead to fair valuation, and we present a method to measure the difference between the two valuations. This difference can indicate the cost of efficient hedging compared to fair valuation, but it can also highlight potential inconsistencies in the hedging process due to the presence of financial positions similar to arbitrage, called Good Deals. Our approach can identify these inconsistencies and can be applied to other hedging methods. Interestingly, we observe that fair hedging is equivalent to efficient hedging when Good Deals are eliminated, which suggests that fair valuation can serve as a benchmark for insurance regulation. Therefore, our results suggest that fair valuation is a more reliable valuation method, regardless of the fact that if the regulatory authority chooses to exclude financial positions such as Good Deals