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Staff Reports
No Good Deals—No Bad Models
December 2012 Number 589
Revised March 2013
Revised March 2013
JEL classification: G12, G13
Faced with the problem of pricing complex contingent claims, an investor seeks to make his valuations robust to model uncertainty. We construct a notion of a model-uncertainty-induced utility function and show that model uncertainty increases the investor's effective risk aversion. Using the model-uncertainty-induced utility function, we extend the "No Good Deals" methodology of Cochrane and Saá-Requejo (2000) to compute lower and upper good-deal bounds in the presence of model uncertainty. We illustrate the methodology using some numerical examples.
Available only in PDF
53 pages / 517 kb
53 pages / 517 kbTools
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