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Dry Markets and Statistical Arbitrage Bounds for European Derivatives

  • Matos, Joao Amaro de
  • Lacerda, Ana

We derive statistical arbitrage bounds for the buying and selling price of European derivatives under incomplete markets. In this paper, incompleteness is generated due to the fact that the market is dry, i.e., the underlying asset cannot be transacted at certain points in time. In particular, we re¯ne the notion of statistical arbitrage in order to extend the procedure for the case where dryness is random, i.e., at each point in time the asset can be transacted with a given probability. We analytically characterize several properties of the statistical arbitragefree interval, show that it is narrower than the super-replication interval and dominates somehow alternative intervals provided in the literature. Moreover, we show that, for su±ciently incomplete markets, the statistical arbitrage interval contains the reservation price of the derivative.

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File URL: http://fesrvsd.fe.unl.pt/WPFEUNL/WP2006/wp479.pdf
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Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp479.

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Length: 57 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:unl:unlfep:wp479
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  1. Hansen, Lars Peter & Jagannathan, Ravi, 1991. "Implications of Security Market Data for Models of Dynamic Economies," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 225-62, April.
  2. Longstaff, Francis A, 2001. "Optimal Portfolio Choice and the Valuation of Illiquid Securities," Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 407-31.
  3. 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.
  4. John H. Cochrane & Jesus Saa-Requejo, 2000. "Beyond Arbitrage: Good-Deal Asset Price Bounds in Incomplete Markets," Journal of Political Economy, University of Chicago Press, vol. 108(1), pages 79-119, February.
  5. Oleg Bondarenko, 2003. "Statistical Arbitrage and Securities Prices," Review of Financial Studies, Society for Financial Studies, vol. 16(3), pages 875-919, July.
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