Efficient Option Risk Measurement With Reduced Model Risk

Mitra, S. 2017. Efficient Option Risk Measurement With Reduced Model Risk. Insurance: Mathematics and Economics. 72, pp. 163-174. https://doi.org/10.1016/j.insmatheco.2016.09.006

TitleEfficient Option Risk Measurement With Reduced Model Risk
TypeJournal article
AuthorsMitra, S.
Abstract

Options require risk measurement that is also computationally efficient as it is important to derivatives risk management. There are currently few methods that are specifically adapted for efficient option risk measurement. Moreover, current methods rely on series approximations and incur significant model risks, which inhibit their applicability for risk management.

In this paper we propose a new approach to computationally efficient option risk measurement, using the idea of a replicating portfolio and coherent risk measurement. We find our approach to option risk measurement provides fast computation by practically eliminating nonlinear computational operations. We reduce model risk by eliminating calibration and implementation risks by using mostly observable data, we remove internal model risk for complex option portfolios by not admitting arbitrage opportunities, we are also able to incorporate liquidity or model misspecification risks. Additionally, our method enables tractable and convex optimisation of portfolios containing multiple options. We conduct numerical experiments to test our new approach and they validate it over a range of option pricing parameters.

JournalInsurance: Mathematics and Economics
Journal citation72, pp. 163-174
ISSN0167-6687
Year2017
PublisherElsevier
Accepted author manuscript
License
CC BY-NC-ND 4.0
File Access Level
Open (open metadata and files)
Digital Object Identifier (DOI)https://doi.org/10.1016/j.insmatheco.2016.09.006
Publication dates
Published in print01 Jan 2017
Published online01 Dec 2016

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