Sequential arbitrage measurements and interest rate envelopes
AbstractThis paper proposes new measures that provide us with the level of sequential arbitrage in bond markets. All the measures vanish in an arbitrage-free market and all of them are positive otherwise. Each measure is generated by a dual pair of optimization problems. Primal problems permit us to compute optimal sequential arbitrage strategies, if available. Each dual problem generates a concrete proxy for the term structure of interest rates. The set of proxies allows us to obtain the exact market price of any bond and may measure several effects. For instance, the credit risk spread of nondefault free bonds, or the embedded option price of callable or extendible bonds. The developed theory has been tested empirically.
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Bibliographic InfoPaper provided by Universidad Carlos III de Madrid in its series Open Access publications from Universidad Carlos III de Madrid with number info:hdl:10016/14001.
Length: 376 p.
Date of creation: Sep 2008
Date of revision:
Publication status: Published in Journal of Optimization Theory and Applications (2008-09) v.v.138, p.361-374
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Web page: http://www.uc3m.es
Portfolio optimization; Sequential arbitrage measurements; Term structure of interest rates; Embedded option premiums;
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- Kempf, Alexander & Korn, Olaf, 1998. "Trading System and Market Integration," Journal of Financial Intermediation, Elsevier, vol. 7(3), pages 220-239, July.
- Ioffe, Ioulia D., 2002. "Arbitrage bounds in markets with noisy prices and the puzzle of negative option prices implicit in bonds," Journal of Banking & Finance, Elsevier, vol. 26(6), pages 1199-1228, June.
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