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Federal Reserve Bank of New York
Staff Reports
No good deals—no bad models
Nina Boyarchenko
Mario Cerrato
John Crosby
Stewart Hodges
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 Saá-Requejo (2000) to compute lower and upper good-deal bounds in the presence of model uncertainty. We illustrate the methodology using some numerical examples.


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Nina Boyarchenko & Mario Cerrato & John Crosby & Stewart Hodges, No good deals—no bad models, Federal Reserve Bank of New York, Staff Reports 589, 2012.
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Keywords: Investments ; Econometric models ; Uncertainty ; Asset pricing
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