On the no-arbitrage condition in option implied trees
AbstractThe aim of this paper is to discuss the no-arbitrage condition in option implied trees based on forward induction and to propose a no-arbitrage test that rules out the negative probabilities problem and hence enhances the pricing performance. The no-arbitrage condition takes into account two main features: the position of the node in the tree and the relation between the dividend yield and the risk-free rate. The proposed methodology is tested in and out of sample with Italian index options data and findings support a good pricing performance.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Elsevier in its journal European Journal of Operational Research.
Volume (Year): 193 (2009)
Issue (Month): 1 (February)
Contact details of provider:
Web page: http://www.elsevier.com/locate/eor
Finance No-arbitrage condition Binomial tree Implied volatility Calibration;
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- M. Brunetti & C. Torricelli, 2007. "The internal and cross market efficiency in index option markets: an investigation of the Italian market," Applied Financial Economics, Taylor and Francis Journals, vol. 17(1), pages 25-33.
- Jens Carsten Jackwerth., 1996.
"Generalized Binomial Trees,"
Research Program in Finance Working Papers
RPF-264, University of California at Berkeley.
- Brandt, Michael W. & Wu, Tao, 2002. "Cross-sectional tests of deterministic volatility functions," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 525-550, December.
- Brunetti, Marianna & Torricelli, Costanza, 2005. "Put-call parity and cross-markets efficiency in the index options markets: evidence from the Italian market," International Review of Financial Analysis, Elsevier, vol. 14(5), pages 508-532.
- Bates, David S., 2003. "Empirical option pricing: a retrospection," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 387-404.
- Mark Britten-Jones & Anthony Neuberger, 2000. "Option Prices, Implied Price Processes, and Stochastic Volatility," Journal of Finance, American Finance Association, vol. 55(2), pages 839-866, 04.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley.
- Hentschel, Ludger, 2003. "Errors in Implied Volatility Estimation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(04), pages 779-810, December.
- Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
- Ledoit, Olivier & Santa-Clara, Pedro & Yan, Shu, 2002. "Relative Pricing of Options with Stochastic Volatility," University of California at Los Angeles, Anderson Graduate School of Management qt7jp8f42t, Anderson Graduate School of Management, UCLA.
- Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
- Bernard Dumas & Jeff Fleming & Robert E. Whaley, 1998. "Implied Volatility Functions: Empirical Tests," Journal of Finance, American Finance Association, vol. 53(6), pages 2059-2106, December.
- Silvia Muzzioli, 2011. "Corridor implied volatility and the variance risk premium in the Italian market," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 11112, Universita di Modena e Reggio Emilia, Facoltà di Economia "Marco Biagi".
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wendy Shamier).
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.