No good deals—no bad models

Boyarchenko, Nina; Cerrato, Mario; Crosby, John; Hodges, Stewart

Report

No good deals—no bad models

Abstract: Faced with the problem of pricing complex contingent claims, investors seek to make their valuations robust to model uncertainty. We construct a notion of a model-uncertainty-induced utility function and show that model uncertainty increases investors? effective risk aversion. Using this utility function, we extend the ?no good deals? methodology of Cochrane and Sa-Requejo (2000) to compute lower and upper good-deal bounds in the presence of model uncertainty. We illustrate the methodology using some numerical examples.

Keywords: Investments; Econometric models; Uncertainty; Asset pricing;