Calibration risk for exotic options

Arbeitspapier

Option pricing models are calibrated to market data of plain vanillas by minimization of an error functional. From the economic viewpoint, there are several possibilities to measure the error between the market and the model. These different specifications of the error give rise to different sets of calibrated model parameters and the resulting prices of exotic options vary significantly. These price differences often exceed the usual profit margin of exotic options. We provide evidence for this calibration risk in a time series of DAX implied volatility surfaces from April 2003 to March 2004. We analyze in the Heston and in the Bates model factors influencing these price differences of exotic options and finally recommend an error functional. Moreover, we determine the model risk of these two stochastic volatility models for the time series and consider its relation to calibration risk.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: SFB 649 Discussion Paper ; No. 2006,001

Classification and Topics

• Classification: Wirtschaft ; Estimation: General ; Asset Pricing; Trading Volume; Bond Interest Rates
• Subject: calibration risk ; calibration ; model risk ; Heston model ; Bates model ; barrier option ; cliquet option

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Detlefsen, Kai ; Härdle, Wolfgang Karl
• Event: Veröffentlichung
• (who): Humboldt University of Berlin, Collaborative Research Center 649 - Economic Risk
• (where): Berlin
• (when): 2006

Further information

• Handle: http://hdl.handle.net/10419/25084
• Last update: 10.03.2025, 11:43 AM CET