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Hedging with Small Uncertainty Aversion

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  • Sebastian Herrmann
  • Johannes Muhle-Karbe
  • Frank Thomas Seifried

Abstract

We study the pricing and hedging of derivative securities with uncertainty about the volatility of the underlying asset. Rather than taking all models from a prespecified class equally seriously, we penalise less plausible ones based on their "distance" to a reference local volatility model. In the limit for small uncertainty aversion, this leads to explicit formulas for prices and hedging strategies in terms of the security's cash gamma.

Suggested Citation

  • Sebastian Herrmann & Johannes Muhle-Karbe & Frank Thomas Seifried, 2016. "Hedging with Small Uncertainty Aversion," Papers 1605.06429, arXiv.org.
  • Handle: RePEc:arx:papers:1605.06429
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    References listed on IDEAS

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