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arXiv · 2207.02948

Cost-efficient Payoffs under Model Ambiguity

Carole Bernard·Gero Junike·Thibaut Lux·Steven Vanduffel
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Abstract

Dybvig (1988a,b) solves in a complete market setting the problem of finding a payoff that is cheapest possible in reaching a given target distribution ("cost-efficient payoff"). In the presence of ambiguity, the distribution of a payoff is, however, no longer known with certainty. We study the problem of finding the cheapest possible payoff whose worst-case distribution stochastically dominates a given target distribution ("robust cost-efficient payoff") and determine solutions under certain conditions. We study the link between "robust cost-efficiency" and the maxmin expected utility setting of Gilboa and Schmeidler, as well as more generally with robust preferences in a possibly non-expected utility setting. Specifically, we show that solutions to maxmin robust expected utility are necessarily robust cost-efficient. We illustrate our study with examples involving uncertainty both on the drift and on the volatility of the risky asset.

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Carole Bernard, Gero Junike, Thibaut Lux, Steven Vanduffel. 2022-07-06. Cost-efficient Payoffs under Model Ambiguity. https://arxiv.org/abs/2207.02948

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