Faculty of Economics and Business Administration Publications Database

A Note on the Impact of Parameter Uncertainty on Barrier Derivatives

Marcos, Escobar
Volume: 4
Number: 4
Link External Source: Online Version
Year: 2016
Keywords: Barrier options; Estimation risk; Random covariance; Structured products

This paper presents a comprehensive extension of pricing two-dimensional derivatives depending on two barrier constraints. We assume randomness on the covariance matrix as a way of generalizing. We analyse common barrier derivatives, enabling us to study parameter uncertainty and the risk related to the estimation procedure (estimation risk). In particular, we use the distribution of empirical parameters from IBM and EURO STOXX 50. The evidence suggests that estimation risk should not be neglected in the context of multidimensional barrier derivatives, as it could cause price differences of up to 70%.