Read e-book online Absence of Arbitrage Valuation: A Unified Framework for PDF

By P. Glabadanidis

ISBN-10: 1137372877

ISBN-13: 9781137372871

ISBN-10: 1349476390

ISBN-13: 9781349476398

Absence of Arbitrage Valuation provides a unified asset pricing procedure via absence of arbitrage and applies this framework to such disparate fields as fastened source of revenue defense pricing, foreign currencies spots, and ahead premiums.

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Extra resources for Absence of Arbitrage Valuation: A Unified Framework for Pricing Assets and Securities

Example text

We know from previous sections that the payoff of a call option is increasing the underlying stock price at the maturity of the call option. Consider taking the protective put option example we have just considered and adding a call option on the same stock and with the same maturity date and a strike price of $55. 2 Payoffs of protective put. price finishes away from $55 on the maturity date. This type of an option strategy is referred to as a straddle. It is clearly a profitable strategy as long as the underlying stock price is volatile.

5 $75 ??? 25 54 Absence of Arbitrage Valuation It is easy to verify that for this model the risk-neutral probability is equal to 50% in either state and that both state prices are equal to 4/9: p = 0. 5 PV$1U = 49 , 1 − p = 0. 5 PV$1D = 49 . 5 ? 75 One possibility of obtaining better and better approximations is to continue subdividing into more and more subperiods holding the time to maturity fixed.

Next, suppose that R > U > D. In this case, the return of the risk-free bond dominates the returns of the risky security in both states of the world. An arbitrage strategy here would involve selling short the risky underlying security and investing the proceeds in the risk-free bond. We are guaranteed to make a profit in both states of the world and, once again, we are not risking anything. Therefore, this inequality is also untenable. The only viable arbitrage-free condition for the parameters of the binomial option pricing model is the following: U > R > D.

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Absence of Arbitrage Valuation: A Unified Framework for Pricing Assets and Securities by P. Glabadanidis

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