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Regulatory-Compliant Derivatives Pricing is Not Risk-Neutral

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  • Chris Kenyon
  • Andrew Green
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    Abstract

    Regulations impose idiosyncratic capital and funding costs for holding derivatives. Capital requirements are costly because derivatives desks are risky businesses; funding is costly in part because regulations increase the minimum funding tenor. Idiosyncratic costs mean no single measure makes derivatives martingales for all market participants. Hence Regulatory-compliant pricing is not risk-neutral. This has implications for exit prices and mark-to-market.

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    File URL: http://arxiv.org/pdf/1311.0118
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1311.0118.

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    Date of creation: Nov 2013
    Date of revision: Aug 2014
    Handle: RePEc:arx:papers:1311.0118

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    Web page: http://arxiv.org/

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    1. Hiroaki Kaido & Halbert White, 2009. "Inference on Risk-Neutral Measures for Incomplete Markets," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 7(3), pages 199-246, Summer.
    2. Tuckman, Bruce & Vila, Jean-Luc, 1992. " Arbitrage with Holding Costs: A Utility-Based Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1283-302, September.
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