Markets That Don'T Replicate Any Option
It is well known from the work of S. Ross that a securities market is complete if and only if each call option can be replicated using available securities. The present short note announces the following surprising complementary result to Ross' important contribution. . If the number of securities is less than half the number of states of the world, then not a single option can be replicated by traded securities. This provides further strong motivation for relaxing the assumption of a perfect market in the theory of option pricing and portfolio insurance.
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- Ross, Stephen A, 1976. "Options and Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 90(1), pages 75-89, February.
- Edirisinghe, Chanaka & Naik, Vasanttilak & Uppal, Raman, 1993. "Optimal Replication of Options with Transactions Costs and Trading Restrictions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(01), pages 117-138, March.
- Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
- Green, Richard C. & Jarrow, Robert A., 1987. "Spanning and completeness in markets with contingent claims," Journal of Economic Theory, Elsevier, vol. 41(1), pages 202-210, February.
- Brown, Donald J & Ross, Stephen A, 1991.
"Spanning, Valuation and Options,"
Springer, vol. 1(1), pages 3-12, January.
- Naik, Vasanttilak & Uppal, Raman, 1994. "Leverage Constraints and the Optimal Hedging of Stock and Bond Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(02), pages 199-222, June.
- Hayne E. Leland., 1979.
"Who Should Buy Portfolio Insurance?,"
Research Program in Finance Working Papers
95, University of California at Berkeley.
- Broadie, Mark & Cvitanic, Jaksa & Soner, H Mete, 1998. "Optimal Replication of Contingent Claims under Portfolio Constraints," Review of Financial Studies, Society for Financial Studies, vol. 11(1), pages 59-79.
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