Coherent acceptability measures in multiperiod models

Berend Roorda, J.M. Schumacher, Jacob Engwerda

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71 Citations (Scopus)
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Abstract

The framework of coherent risk measures has been introduced by Artzner et al. (1999; Math. Finance 9, 203–228) in a single-period setting. Here, we investigate a similar framework in a multiperiod context. We add an axiom of dynamic consistency to the standard coherence axioms, and obtain a representation theorem in terms of collections of multiperiod probability measures that satisfy a certain product property. This theorem is similar to results obtained by Epstein and Schneider (2003; J. Econ. Theor. 113, 1–31) and Wang (2003; J. Econ. Theor. 108, 286–321) in a different axiomatic framework. We then apply our representation result to the pricing of derivatives in incomplete markets, extending results by Carr, Geman, and Madan (2001; J. Financial Econ. 32, 131–167) to the multiperiod case. We present recursive formulas for the computation of price bounds and corresponding optimal hedges. When no shortselling constraints are present, we obtain a recursive formula for price bounds in terms of martingale measures.
Original languageEnglish
Pages (from-to)589-612
Number of pages24
JournalMathematical finance
Volume15
Issue number4
DOIs
Publication statusPublished - 2005

Keywords

  • Incomplete markets
  • Option pricing
  • Coherent risk measures
  • Acceptability measures
  • Robustness
  • Dynamic consistency

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