Capturing parameter risk with convex risk measures
The paper provides a new method which uses convex risk measures to quantify parameter risk and to translate it into prices. The authors introduce the notion of risk-capturing functionals and prices based on a necessarily available distribution on the parameter set. Explicit examples are provided where the average value at risk and the entropic risk measure are used. It is shown that ``for some classes of risk-capturing functionals the risk-captured price preserves weak convergence of the distributions. In particular, the risk-captured price generated by the distributions of a consistent sequence of estimators converges to the true price. For asymptotically normally distributed estimators the authors provide large sample approximations for risk-captured prices. To acknowledge parameter risk in case of calibration to market prices, they create a parameter distribution from the pricing error functional, which allows them ``to compare the intrinsic parameter risk of the stochastic volatility models of Heston and Barndorff-Nielsen and Shephard as well as the variance gamma option pricing model by prising different exotics.
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