Staff Reports
No Good Deals—No Bad Models
December 2012  Number 589
Revised March 2013
JEL classification: G12, G13

Authors: Nina Boyarchenko, Mario Cerrato, John Crosby, and Stewart Hodges

Faced with the problem of pricing complex contingent claims, an investor seeks to make his valuations robust to model uncertainty. We construct a notion of a model-uncertainty-induced utility function and show that model uncertainty increases the investor's effective risk aversion. Using the model-uncertainty-induced 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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