a model of financial instrument and portfolio behavior that provides a benchmark of return and risk for capital budgeting and securities analysis. It can be used to create portfolios that track a market index, estimate the risk of an asset allocation strategy, or estimate the response of a portfolio to economic developments.
"Limits of Arbitrage" theories require that the marginal investor in a particular asset market be a specialized arbitrageur. The paper examines the mortgage-backed securities market in this light, as casual empiricism suggests that investors in the MBS market do seem to be very specialized. It shows that risks that seem...
This paper considers life insurance, property and casualty insurance, securities, and commercial firms as potential matches for banks. It examines two types of evidence extracted from stock price data. First, option-pricing theory is used to compute a direct measure of diversification gains from potential consolidation. These results identify potential gains...
This paper develops congestion theory and congestion pricing theory from its micro-foundations, the interaction of two or more vehicles. Using game theory, with a two-player game it is shown that the emergence of congestion depends on the players' relative valuations of early arrival, late arrival, and journey delay. Congestion pricing...
Although tax arbitrage is central to the literatures on tax capitalization, implicit taxes, and even capital structure, there is little empirical evidence of the extent to which firms actually engage in tax arbitrage. This paper provides some evidence on the topic by focusing on a simple and observable corporate arbitrage...
A diversified portfolio of risk arbitrage positions produces an abnormal return of 0.6–0.9% per month over the period from 1981 to 1996. It trace these profits to practical limits on risk arbitrage. In the model of risk arbitrage, arbitrageurs’ risk-bearing capacity is constrained by deal completion risk and the size...
Classical theories of financial markets assume an infinitely liquid market and that all traders act as price takers. This theory is a good approximation for highly liquid stocks, although even there it does not apply well for large traders or for modeling transaction costs. This paper extends the classical approach...
This paper considers the pricing of contingent claims using an approach developed and used in insurance pricing. The approach is of interest and significance because of the increased integration of insurance and financial markets and also because insurance related risks are trading in financial markets as a result of securitization...
The arbitrage-free range of values of the loss leg of an nth-to-default swap, and the arbitrage-free range of premium payments for such a swap, are derived for homogeneous baskets of arbitrary numbers of reference entities. Elementary arbitrage arguments are given which show that arbitrage opportunities exist if the prices lie...
Merger arbitrage is widely considered one of the principal areas of hedge fund investment. While the investment process of merger arbitrage is generally known, less information exists, at least in the practitioner community, as to academic research as to the basis for various merger activity as well as to the...
Although tax arbitrage is central to the literatures on tax capitalization, implicit taxes, and even capital structure, there is little empirical evidence of the extent to which firms actually engage in tax arbitrage. This paper provides some evidence on the topic by focusing on a simple and observable corporate arbitrage...
The capital asset pricing model CAPM of William Sharpe (1964) and John Lintner (1965) marks the birth of asset pricing theory (resulting in a Nobel Prize for Sharpe in 1990). Before their breakthrough, there were no asset pricing models built from first principles about the nature of tastes and investment...
One main problem of credit models, as in to chastic volatility models for instance, is that the range of arbitrage prices of risky bonds and credit derivatives is generally very wide. In this article, we present a model for pricing options on the spread in an environment where the rating...
This paper applies martingale pricing theory to the problems of pricing European and American options, as well as forwards and futures contracts. It first considers the problem of pricing European and American options. The paper interprets the classic binomial model in the context of martingale pricing theory and uses it...
This paper examines the extent to which a false detection of Pricing-To-Market pseudo PTM arises from the use of unit value data. To do so, the authors analyze two scenarios. Both scenarios involve a monopolist located in the home country producing a low- and high-quality variety of a good. In...
Arbitrage, in its purest form, is defined as the purchase of securities on one market for immediate resale on another market in order to profit from a price discrepancy. This results in immediate risk-free profit. Arbitrage is a very broad form of trading that encompasses many strategies; however, they all...
An important principle in options pricing is called put-call parity. It says that the value of a call option at one strike price implies a certain fair value for the corresponding put, and vice versa. The argument for this pricing relationship relies on the arbitrage opportunity that results if there...
This document presents a statement of the calibration problem for multi-asset equity derivatives. It then illustrates a weighted Monte Carlo simulation (max-entropy and applies it to Arbitrage Pricing of Basket Options. The presentation then draws a comparison between WMC and Steepest Descent Method. Finally, it provides comments on correlation skew...
This article develops an econometric framework for i estimating excess returns of the security process from high frequency derivative prices, ii testing for risk neutral pricing, and iii measuring premiums outside the no-arbitrage pricing model. Applying quasi-likelihood and Feynman construct the estimator–Kac theory to the risk neutral contingent claims pricing...
In capital budgeting, problems future cash flows are discounted using the expected one period returns of the investment. This paper establishes a theory that relates this approach to the assumption that markets are free of arbitrage. The goal is to uncover implicit assumptions on the set of cash flow distributions...
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