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Free Lunches with Vanishing Risks Most Likely Exist

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  • Eckhard Platen
  • Kevin Fergusson

Abstract

The hypothesis that there do not exist free lunches with vanishing risk (FLVRs) in the real market underpins the popular risk-neutral pricing and hedging methodology in quantitative finance. The paper documents the fact that this hypothesis can be safely rejected. It performs extremely accurately the hedging of an extreme-maturity zero-coupon bond (ZCB). This hedge is part of a portfolio that starts with zero initial wealth and invests dynamically in a total return stock market index and the savings account to generate at the maturity date of the extreme-maturity ZCB a strictly positive amount with strictly positive probability, which represents an FLVR. The fact that FLVRs naturally exist in the real market can be accommodated theoretically under the benchmark approach.

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  • Eckhard Platen & Kevin Fergusson, 2025. "Free Lunches with Vanishing Risks Most Likely Exist," Papers 2508.07108, arXiv.org.
    • Handle: RePEc:arx:papers:2508.07108
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    File URL: http://arxiv.org/pdf/2508.07108
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