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Market models with optimal arbitrage

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  • Huy N. Chau
  • Peter Tankov

Abstract

We construct and study market models admitting optimal arbitrage. We say that a model admits optimal arbitrage if it is possible, in a zero-interest rate setting, starting with an initial wealth of 1 and using only positive portfolios, to superreplicate a constant c>1. The optimal arbitrage strategy is the strategy for which this constant has the highest possible value. Our definition of optimal arbitrage is similar to the one in Fernholz and Karatzas (2010), where optimal relative arbitrage with respect to the market portfolio is studied. In this work we present a systematic method to construct market models where the optimal arbitrage strategy exists and is known explicitly. We then develop several new examples of market models with arbitrage, which are based on economic agents' views concerning the impossibility of certain events rather than ad hoc constructions. We also explore the concept of fragility of arbitrage introduced in Guasoni and Rasonyi (2012), and provide new examples of arbitrage models which are not fragile in this sense.

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  • Huy N. Chau & Peter Tankov, 2013. "Market models with optimal arbitrage," Papers 1312.4979, arXiv.org.
    • Handle: RePEc:arx:papers:1312.4979
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    References listed on IDEAS

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    1. Eckhard Platen, 2006. "A Benchmark Approach To Finance," Mathematical Finance, Wiley Blackwell, vol. 16(1), pages 131-151, January.
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    3. Christian Bender, 2012. "Simple arbitrage," Papers 1210.5391, arXiv.org.
    4. Daniel Fernholz & Ioannis Karatzas, 2010. "On optimal arbitrage," Papers 1010.4987, arXiv.org.
    5. Johannes Ruf & Wolfgang Runggaldier, 2013. "A Systematic Approach to Constructing Market Models With Arbitrage," Papers 1309.1988, arXiv.org, revised Dec 2013.
    6. Alexander Cox & David Hobson, 2005. "Local martingales, bubbles and option prices," Finance and Stochastics, Springer, vol. 9(4), pages 477-492, October.
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    8. Shiqi Song, 2013. "An alternative proof of a result of Takaoka," Papers 1306.1062, arXiv.org.
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    Cited by:

    1. Alexander Vervuurt, 2015. "Topics in Stochastic Portfolio Theory," Papers 1504.02988, arXiv.org.

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