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An investigation of model risk in a market with jumps and stochastic volatility

Author

Listed:
  • Guillaume Coqueret

    (Groupe Sup de Co Montpellier (GSCM) - Montpellier Business School)

  • Bertrand Tavin

    (EM - EMLyon Business School)

Abstract

The aim of this paper is to investigate model risk aspects of variance swaps and forward-start options in a realistic market setup where the underlying asset price process exhibits stochastic volatility and jumps. We devise a general framework in order to provide evidence of the model uncertainty attached to variance swaps and forward-start options. In our study, both variance swaps and forward-start options can be valued by means of analytic methods. We measure model risk using a set of 21 models embedding various dynamics with both continuous and discontinuous sample paths. To conduct our empirical analysis, we work with two major equity indices (S&P 500 and Eurostoxx 50) under different market situations. Our results evaluate model risk between 50 and 200 basis points, with an average value slightly above 100 basis points of the contract notional.

Suggested Citation

  • Guillaume Coqueret & Bertrand Tavin, 2016. "An investigation of model risk in a market with jumps and stochastic volatility," Post-Print hal-02313399, HAL.
    • Handle: RePEc:hal:journl:hal-02313399
    DOI: 10.1016/j.ejor.2016.03.018
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    Citations

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    Cited by:

    1. Ballotta, Laura & Deelstra, Griselda & Rayée, Grégory, 2017. "Multivariate FX models with jumps: Triangles, Quantos and implied correlation," European Journal of Operational Research, Elsevier, vol. 260(3), pages 1181-1199.
    2. Lazar, Emese & Qi, Shuyuan, 2022. "Model risk in the over-the-counter market," European Journal of Operational Research, Elsevier, vol. 298(2), pages 769-784.
    3. Kaeck, Andreas & Seeger, Norman J., 2020. "VIX derivatives, hedging and vol-of-vol risk," European Journal of Operational Research, Elsevier, vol. 283(2), pages 767-782.
    4. Coqueret, Guillaume & Deguest, Romain, 2024. "Unexpected opportunities in misspecified predictive regressions," European Journal of Operational Research, Elsevier, vol. 318(2), pages 686-700.
    5. Cui, Zhenyu & Kirkby, J. Lars & Nguyen, Duy, 2021. "A data-driven framework for consistent financial valuation and risk measurement," European Journal of Operational Research, Elsevier, vol. 289(1), pages 381-398.
    6. Ballotta, Laura & Rayée, Grégory, 2022. "Smiles & smirks: Volatility and leverage by jumps," European Journal of Operational Research, Elsevier, vol. 298(3), pages 1145-1161.
    7. Emese Lazar & Shuyuan Qi & Radu Tunaru, 2020. "Measures of Model Risk in Continuous-time Finance Models," Papers 2010.08113, arXiv.org, revised Oct 2020.
    8. Valeriane Jokhadze & Wolfgang M. Schmidt, 2020. "Measuring Model Risk In Financial Risk Management And Pricing," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 23(02), pages 1-37, April.
    9. Ben-zhang Yang & Jia Yue & Nan-jing Huang, 2017. "Variance swaps under L\'{e}vy process with stochastic volatility and stochastic interest rate in incomplete markets," Papers 1712.10105, arXiv.org, revised Mar 2018.
    10. Guillaume Coqueret & Romain Deguest, 2024. "Unexpected opportunities in misspecified predictive regressions," Post-Print hal-04595355, HAL.
    11. Baule, Rainer & Shkel, David, 2021. "Model risk and model choice in the case of barrier options and bonus certificates," Journal of Banking & Finance, Elsevier, vol. 133(C).
    12. Ben-Zhang Yang & Jia Yue & Nan-Jing Huang, 2019. "Equilibrium Price Of Variance Swaps Under Stochastic Volatility With Lévy Jumps And Stochastic Interest Rate," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(04), pages 1-33, June.

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