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Sequential Arbitrage Measurements and Interest Rate Envelopes

Author

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  • A. Balbás

    (University Carlos III of Madrid)

  • S. López

    (Autonomous University of Madrid)

Abstract

This 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.

Suggested Citation

  • A. Balbás & S. López, 2008. "Sequential Arbitrage Measurements and Interest Rate Envelopes," Journal of Optimization Theory and Applications, Springer, vol. 138(3), pages 361-374, September.
    • Handle: RePEc:spr:joptap:v:138:y:2008:i:3:d:10.1007_s10957-008-9391-5
    DOI: 10.1007/s10957-008-9391-5
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    References listed on IDEAS

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    Cited by:

    1. Balbás, Alejandro & Peng, Yao, 2015. "Sequential arbitrage measurement in bond markets : theory and empirical applications in the Euro-zone," INDEM - Working Paper Business Economic Series id-15-01, Instituto para el Desarrollo Empresarial (INDEM).

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