May 14, 2013
from 05:00 PM to 06:00 PM
|Where||Sidgwick Hall, Newnham College|
|Contact Name||Mette Jamasb|
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John Crosby has worked at a number of investment banks as both a quant and as an fx options trader. He is currently a managing director at Grizzly Bear Capital and a visiting Professor of Finance in the Centre for Economic and Financial Studies at Glasgow University Adam Smith Business School.
This is joint work with Nina Boyarchenko, Mario Cerrato and Stewart Hodges.
Faced with the problem of pricing complex contingent claims, an investor seeks to make his valuation and hedging robust to model uncertainty. Our approach to this problem combines the “No Good Deals" methodology of Cochrane and Saa-Requejo  with elements of the robustness framework of Hansen and Sargent  and of Maenhout . The analysis introduces the notion of a model uncertainty induced utility function and shows how model uncertainty increases an investor's effective risk aversion. The presence of (and aversion to) model uncertainty gives greater weight (i.e. greater than the investor's marginal utility) to states in which losses are relatively large. Further, static hedging, (i.e. hedging an option by taking a “buy-and-hold" position in other assets, as opposed to dynamic hedging with the underlying asset), may become a relatively attractive hedging strategy in the presence of model uncertainty. We illustrate the methodology using some numerical examples.