Berend Roorda, Jacob Engwerda, Hans Schumacher
The coherent risk principles are applied to quantify risk in derivatives under optimal hedging. Some theoretical aspects are discussed, and a fairly general dynamic programming solution is described. For convex European options and risk scenarios defined in terms of interval probabilities, computations are further reduced to a very simple recursion. An application on
S&P 500 option data illustrates the results.
Keywords: Coherent Risk Measures; Robust Hedging;
Interval Model; Limited Downside Risk; Option Pricing; Delta-hedging; Binomial tree; Incomplete Markets