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Generalized Stochastic Arbitrage Opportunities

Author

Listed:
  • Stelios Arvanitis

    (Department of Economics, Athens University of Economics and Business, 10434 Athens, Greece)

  • Thierry Post

    (Graduate School of Business, Nazarbayev University, Astana 010000, Kazakhstan)

Abstract

Concepts are introduced and applied for analyzing and selecting arbitrage portfolios in the face of uncertainty about initial positions and risk preferences. A stochastic arbitrage opportunity is defined as a zero-cost investment portfolio that enhances every feasible host portfolio for all admissible utility functions. The alternative to the existence of such investment opportunities is the existence of a solution to a dual system of asset pricing restrictions based on a class of stochastic discount factors. Feasible approaches to numerical optimization and statistical inference are discussed. Empirical results suggest that equity factor investing is appealing for all risk-averse stock investors with a wide range of initial position and sufficiently low transactions costs by mixing multiple factor portfolios with high after-cost appraisal ratios, low mutual correlation, and negative exposures to the relevant host portfolios. These findings weaken the case for risk-based explanations for the profitability of factor investing.

Suggested Citation

  • Stelios Arvanitis & Thierry Post, 2024. "Generalized Stochastic Arbitrage Opportunities," Management Science, INFORMS, vol. 70(7), pages 4629-4648, July.
    • Handle: RePEc:inm:ormnsc:v:70:y:2024:i:7:p:4629-4648
    DOI: 10.1287/mnsc.2023.4892
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    References listed on IDEAS

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    Cited by:

    1. Stelios Arvanitis, 2025. "Norm Constrained Empirical Portfolio Optimization with Stochastic Dominance: Robust Optimization Non-Asymptotics," Working Paper 1533, Economics Department, Queen's University.

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