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Simple and enlarged separation portfolios. On their Use when Arbitraging and Synthesizing Securities

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  • Rodolfo Apreda

Abstract

This paper seeks to provide a framework for separation portfolios when they are used not only as synthetics of a matching security but also as building blocks of arbitrage portfolios, in a background provided by the CAPM world. Firstly, synthetics are defined by means of a vectorial framework that maps portfolios onto their risk-return profiles. Separation portfolios are extensively analyzed afterwards, establishing three propositions that lay the groundwork for using them as synthetics. Next, a distinction is brought about between plain separation portfolios (which are located on the Capital Market Line) and enlarged separation portfolios (which lie outside the CML). Furthermore, it is shown that simple separation portfolios become synthetics in few cases only, whereas enlarged portfolios allow for synthetics in much wider contexts. Later, arbitrage portfolios are designed by means of simple separation portfolios in the context of the Security Market Line, and also by resorting to the enlarged ones without requiring the SML as a benchmark. Finally, the discussion extends over bond portfolios, to embody their risky features into the viewpoint set forth in the paper.

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Bibliographic Info

Paper provided by Universidad del CEMA in its series CEMA Working Papers: Serie Documentos de Trabajo. with number 233.

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Date of creation: Mar 2003
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Handle: RePEc:cem:doctra:233

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Keywords: Plain Separation Portfolios; Enlarged Separation Portfolios; Synthetics; Portfolios; Arbitrage Portfolios;

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  1. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
  2. James Tobin, 1956. "Liquidity Preference as Behavior Towards Risk," Cowles Foundation Discussion Papers 14, Cowles Foundation for Research in Economics, Yale University.
  3. Sharpe, William F., 1967. "Portfolio Analysis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 2(02), pages 76-84, June.
  4. Rodolfo Apreda, 2000. "Differential Rates of Return and Residual Information Sets (A Discrete Approach)," CEMA Working Papers: Serie Documentos de Trabajo. 177, Universidad del CEMA.
  5. Rodolfo Apreda, 2000. "A transaction costs approach to financial assets rates of return," CEMA Working Papers: Serie Documentos de Trabajo. 161, Universidad del CEMA.
  6. Rodolfo Apreda, 2001. "Arbitrage Portfolios," CEMA Working Papers: Serie Documentos de Trabajo. 184, Universidad del CEMA.
  7. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  8. Rodolfo Apreda, 2001. "Arbitraging mispriced assets with separation portfolios to lessen total risk," CEMA Working Papers: Serie Documentos de Trabajo. 203, Universidad del CEMA.
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Cited by:
  1. Rodolfo Apreda, 2009. "An axiomatic treatment of enlarged separation portfolios and treasurer’s portfolios (with applications to financial synthetics)," CEMA Working Papers: Serie Documentos de Trabajo. 398, Universidad del CEMA.
  2. Rodolfo Apreda, 2004. "Corporate Rent-Seeking and the managerial soft-budget constraint," CEMA Working Papers: Serie Documentos de Trabajo. 283, Universidad del CEMA.

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