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Markets That Don'T Replicate Any Option

  • CHARALAMBOS D. ALIPRANTIS
  • RABEE TOURKY
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    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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    Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 832.

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    Length: 8 pages
    Date of creation: 2002
    Date of revision:
    Handle: RePEc:mlb:wpaper:832
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    1. 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.
    2. Ross, Stephen A, 1976. "Options and Efficiency," The Quarterly Journal of Economics, MIT Press, vol. 90(1), pages 75-89, February.
    3. 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.
    4. Hayne E. Leland., 1979. "Who Should Buy Portfolio Insurance?," Research Program in Finance Working Papers 95, University of California at Berkeley.
    5. 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.
    6. 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.
    7. 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.
    8. Brown, Donald J & Ross, Stephen A, 1991. "Spanning, Valuation and Options," Economic Theory, Springer, vol. 1(1), pages 3-12, January.
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