Measuring the Model Risk of Quadratic Risk Minimizing Hedging Strategies with an Application to Energy Markets

Detering, Nils

doi:10.2139/ssrn.2400670

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The Claim Follows With the Definition Of L T (X φ)1

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2015

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“…[12] shows how a loss distribution under model uncertainty can be constructed, which can then be used to define the usual risk measures such as value-at-risk and expected shortfall.…”

Section: The Claim Follows With the Definition Of L T (X φ)mentioning

confidence: 99%

Model Risk in Incomplete Markets with Jumps

Detering¹,

Packham

2015

Innovations in Quantitative Risk Management

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We are concerned with determining the model risk of contingent claims when markets are incomplete. Contrary to existing measures of model risk, typically based on price discrepancies between models, we develop value-at-risk and expected shortfall measures based on realized P&L from model risk, resp. model risk and some residual market risk. This is motivated, e.g., by financial regulators' plans to introduce extra capital charges for model risk. In an incomplete market setting, we also investigate the question of hedge quality when using hedging strategies from a (deliberately) misspecified model, for example, because the misspecified model is a simplified model where hedges are easily determined. An application to energy markets demonstrates the degree of model error.

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“…[12] shows how a loss distribution under model uncertainty can be constructed, which can then be used to define the usual risk measures such as value-at-risk and expected shortfall.…”

Section: The Claim Follows With the Definition Of L T (X φ)mentioning

confidence: 99%