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Non-Parametric Robust Model Risk Measurement with Path-Dependent Loss Functions

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  • Yu Feng

Abstract

Understanding and measuring model risk is important to financial practitioners. However, there lacks a non-parametric approach to model risk quantification in a dynamic setting and with path-dependent losses. We propose a complete theory generalizing the relative-entropic approach by Glasserman and Xu to the dynamic case under any $f$-divergence. It provides an unified treatment for measuring both the worst-case risk and the $f$-divergence budget that originate from the model uncertainty of an underlying state process.

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  • Yu Feng, 2019. "Non-Parametric Robust Model Risk Measurement with Path-Dependent Loss Functions," Papers 1903.00590, arXiv.org.
    • Handle: RePEc:arx:papers:1903.00590
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    File URL: http://arxiv.org/pdf/1903.00590
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    References listed on IDEAS

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    1. Kerkhof, Jeroen & Melenberg, Bertrand & Schumacher, Hans, 2010. "Model risk and capital reserves," Journal of Banking & Finance, Elsevier, vol. 34(1), pages 267-279, January.
    2. Danielsson, Jon & James, Kevin R. & Valenzuela, Marcela & Zer, Ilknur, 2016. "Model risk of risk models," Journal of Financial Stability, Elsevier, vol. 23(C), pages 79-91.
    3. Rama Cont, 2006. "Model Uncertainty And Its Impact On The Pricing Of Derivative Instruments," Mathematical Finance, Wiley Blackwell, vol. 16(3), pages 519-547, July.
    4. Boucher, Christophe M. & Daníelsson, Jón & Kouontchou, Patrick S. & Maillet, Bertrand B., 2014. "Risk models-at-risk," Journal of Banking & Finance, Elsevier, vol. 44(C), pages 72-92.
    5. Philippe Artzner & Freddy Delbaen & Jean‐Marc Eber & David Heath, 1999. "Coherent Measures of Risk," Mathematical Finance, Wiley Blackwell, vol. 9(3), pages 203-228, July.
    6. Yuhong Xu, 2014. "Robust valuation and risk measurement under model uncertainty," Papers 1407.8024, arXiv.org.
    7. Rama Cont, 2006. "Model uncertainty and its impact on the pricing of derivative instruments," Post-Print halshs-00002695, HAL.
    8. Paul Glasserman & Xingbo Xu, 2014. "Robust risk measurement and model risk," Quantitative Finance, Taylor & Francis Journals, vol. 14(1), pages 29-58, January.
    9. Hans Föllmer & Alexander Schied, 2002. "Convex measures of risk and trading constraints," Finance and Stochastics, Springer, vol. 6(4), pages 429-447.
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    Cited by:

    1. Yu Feng, 2019. "A Thermodynamic Picture of Financial Market and Model Risk," Papers 1904.00151, arXiv.org.

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