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A Note on the Impact of Parameter Uncertainty on Barrier Derivatives

Author

Listed:
  • Marcos Escobar

    (Western University, London, ON N6A 3K7, Canada)

  • Sven Panz

    (Chair of e-Finance, Goethe University Frankfurt, D-60323 Frankfurt am Main, Germany)

Abstract

This paper presents a comprehensive extension of pricing two-dimensional derivatives depending on two barrier constraints. We assume randomness on the covariance matrix as a way of generalizing. We analyse common barrier derivatives, enabling us to study parameter uncertainty and the risk related to the estimation procedure (estimation risk). In particular, we use the distribution of empirical parameters from IBM and EURO STOXX50. The evidence suggests that estimation risk should not be neglected in the context of multidimensional barrier derivatives, as it could cause price differences of up to 70%.

Suggested Citation

  • Marcos Escobar & Sven Panz, 2016. "A Note on the Impact of Parameter Uncertainty on Barrier Derivatives," Risks, MDPI, vol. 4(4), pages 1-25, September.
    • Handle: RePEc:gam:jrisks:v:4:y:2016:i:4:p:35-:d:79467
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    References listed on IDEAS

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