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Arbitrage with fixed costs and interest rate models

Listed author(s):
  • Elyès Jouini


  • Hedi Kallal

    (Citadel investment Group)

  • Clotilde Napp

    (Dauphine & CREST)

In this paper, we start by considering market models with fixed costs; in such a context, we characterize the absence of arbitrage opportunity and we provide pricing rules. We then apply these results to extend some classical interest rate and option pricing models. In particular, we prove that the quite surprising result obtained by Dybvig-Ingersoll-Ross $\left( 1996\right) $, which asserts that, under the assumption of absence of arbitrage, long zero-coupon rates can never fall, is no longer true in models with fixed costs. Models where the long rate follows a diffusion process as in Brennan-Schwartz $\left( 1979\right) $ are no more to be rejected for arbitrage considerations.

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Paper provided by EconWPA in its series Finance with number 0312002.

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Date of creation: 05 Dec 2003
Handle: RePEc:wpa:wuwpfi:0312002
Note: Type of Document - pdf; prepared on Win98
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