Incorporating statistical model error into the calculation of acceptability prices of contingent claims

Understand

The determination of acceptability prices of contingent claims requires the choice of a stochastic model for the underlying asset price dynamics.

• Given this model, optimal bid and ask prices can be found by stochastic optimization.
• However, the model for the underlying asset price process is typically based on data and found by a statistical estimation procedure.
• We define a confidence set of possible estimated models by a nonparametric neighborhood of a baseline model.