why is vega a measure of price uncertainty?

This forum is to discuss the book "the concepts and practice of mathematical finance" by Mark Joshi.

why is vega a measure of price uncertainty?

Postby sunnyday » Fri Sep 13, 2013 9:34 am

Hello,

In chapter 4, p82, last paragraph, I read that vega gives a natural measure of the uncertainty of the price. Further, the book has that since vols are estimated rather than measured, the change in price for changing vol by 1% gives us a good measure of the size of the range the correct price may lie in. I see that if we have a bound on future vol (say lower bound is sigma1 and upper bound is sigma2), then by calculating two prices based on the two vols, we would have a range for correct option price. However, I don't see how Vega alone could give us this price range estimate. Would you please elaborate?

Many thanks!
sunnyday
 
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