New study reveals hidden risks in pricing and hedging financial claims
The article discusses how to measure the risk of using incorrect models to price financial options. By considering different possible models for asset prices, researchers calculated potential losses from model errors. They used market data to combine these models and determine the overall risk. The study shows that having enough capital set aside can protect against unexpected losses due to model errors. Additionally, they applied this framework to calculate the risk of a specific type of option when using a particular hedging strategy.