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.
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Bibliographic InfoArticle provided by Elsevier in its journal European Journal of Operational Research.
Volume (Year): 193 (2009)
Issue (Month): 1 (February)
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Web page: http://www.elsevier.com/locate/eor
Finance No-arbitrage condition Binomial tree Implied volatility Calibration;
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