Rethinking Valuation and Pricing Models

3

Scenario Analysis in Charge of Model Selection

Péter Dobránszky

BNP Paribas and Katholieke Universiteit Leuven, Belgium

Chapter Outline

3.1 Introduction to Model Risk

3.2 Classical Calibration Procedure

3.3 Processes, Dynamics and Model Definition

3.4 Importance of Risk Premia

3.5 Equity Volatility Modeling

3.6 Foreign Exchange Volatility Modeling

3.7 Conclusions

3.8 Note

References

3.1 Introduction to Model Risk

In this chapter, we need to distinguish models and rules-of-thumb, the latter of which are often considered as actually being models in the literature. We may build models or apply rules-of-thumb for various reasons. In the following paragraphs we list various cases.

In some cases we know the price of a financial instrument, but we ...