# Tag Info

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I teach Derivative Securities in the mathematical finance program at NYU and was rather surprised to learn that there is no proof of the FTAP that is accessible to masters level students. So I wrote this. It is a simple proof for the discrete time case. One bonus of the proof of the one period case is that it tells you how to find the arbitrage if one ...

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This question requires a comprehensive answer, perhaps beyond the confines of my input box :) Suffices here to state the following: The First Fundamental Theorem of Asset Pricing states that in an arbitrage-free market, there exists a ("net") present value function, that is, a linear valuation rule whose value is zero when evaluated in any traded cash-flow. ...

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This is not an arbitrage because the transaction costs of the basket of goods is too high. Ever try to sell an item on eBay? I doubt you'll get 2-3% more for it next year, even new in box. Some of the items in the basket are current consumption goods. Good luck selling those fresh fruits and vegetables next year for 2-3% more than you paid. Others are ...

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In the derivatives context, "arbitrage free" means almost surely for the probability measure under consideration. This is in opposition with statistical arbitrage used at high frequencies for example. More precisely the assumption is that there is no $T\geq 0$ and self-financed portfolio $V$ such that $V_0 = 0$, $P(V_T < 0) = 0$ and $P(V_T > 0) > ... 4 The dynamics of the underlying stock process are obviously crucial to the derivative's price. Thus if you don't necessarily assume$S_t$to be log normally distributed (B&S-Model) you won't get the same price even if the market is arbitrage free. Example: Assume$S_t=C \forall t \in \mathbb{R}^+$and$r=0$. Thus$S_t$is constant and the interest ... 3 A very good book covering such fundamentals with no or only a minimal amount of maths — highly recommended! Puzzles of Finance: Six Practical Problems and Their Remarkable Solutions by Mark P. Kritzman The topics that are covered here are: Siegel's Paradox Likelihood of Loss Time Diversification Why the Expected Return Is Not To Be Expected Half Stocks ... 3 I think that you are missing one key condition on the call prices that I would say is standard, namely that the call prices should be bounded below by an "intrinsic" value. Specifically, we would expect$C(K) \ge (S-e^{-rT}K)_+$, and this can easily be seen to yield a static arbitrage if violated. This condition (in a slightly different form) can be found ... 2 Here's an answer from a purely statistical point of view: http://www.duke.edu/~rnau/regnotes.htm#constant And another from Cross Validated: http://stats.stackexchange.com/questions/7948/when-is-it-ok-to-remove-the-intercept-in-lm The lean in both cases is to include the intercept unless there is a strong theoretical reason. A more satisfying answer would ... 2 (If I remember well,) the local nature of the equivalent measure in the NFLVR theory comes from the fact that the market$S$is a locally bounded semi-martingale. If it is bounded, you obtain an equivalent martingale measure. Should be in A general version of the fundamental theorem of asset pricing, by Freddy Delbaen and Walter Schachermayer (thanks to ... 2 It does not seem you feel the question is answered so I will try to elaborate over what I think seems to bother you. Let$S_t = e^{(\mu -\sigma^2/2) t + \sigma W_t}$be the stock price process and$B_t=e^{rt}$be the risk free. The arbitrage you describe is then choosing a nice$\varepsilon >0$and setting$\tilde{T}=\inf \{t>0 : (\mu -r ...

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No this is not a risk free arbitrage. What you are talking about is modeling a stock price with GBM and it has nothing to do with Black-Scholes. Black-Scholes is an option pricing formula that assumes that stocks follow GBM (which is a bad assumption to begin with but we won't get into that). What you are talking about doing is taking on leverage. $... 1 From my knowledge, Law of One Price is defined as: If two assets provide the same cashflows, they must have the same price. This is the justification to price options by a replicating portfolio. The model here seems to assume some European Claims 1-period model, which means$V_1$represents a final payoff. At the (only) prior time$t=0$, the values of two ... 1 You can view the arbitrage-free statement as being about infinitely liquid trading. If one has to trade$x$by paying a half-spread$\nu$, and you have a trivial payoff$\Phi(\cdot) \equiv 1+R$then there is no solution. You would be trying to solve $$(1+R)x - \nu + suy = (1+R)x = (1+R)x - \nu + sdy$$ 1 Intuitively, holding$\delta$stocks in your portfolio is going to make you money if the stock goes up (but you're going to lose on the option you've sold), and lose you money if the stock goes down (but you make on the option which becomes worthless). The equality is the basis for the concept of$\delta$-neutrality, ie whatever happens, your portfolio ... 1 Call Delta is generally defined as $$\Delta_C=\partial_S C=\frac{dC}{dS}=\frac{C_u-C_d}{S_u-S_d}$$, so it is the derivative or tangential change in$C$from change in$S$, discretized in the Binomial Model. As we know, this derivative goes symmetrically both ways, when$C_u$goes up or$C_d$down, so one can in general rewrite this equation: $$\Delta ... 1 In general, the arbitrage-free price process V_t at time 0 \le t \le T for a European claim X =f(S_T) under the B-S model (which it looks like you have) is given by$$V_t(X) = B_t\mathbb{E}_\mathbb{Q}[B_T^{-1}X | \mathcal{F}_t],$$where$B_t$is the bond price process,$\mathbb{Q}$is the measure making the discounted B-S stock price process a ... 1 1) If some process$V_t$is a martingale under some measure$Q$, we can always write$V_t = \mathbb{E}^Q_t[V_T]$. It is simply a definition of a martingale. 2) Next question is "in which measure would my process be a martingale"? How do people in textbooks answer? They say, "we will measure the performance of your portfolio relative to money market ... 1 For the first one absurd reasoning allows you to construct an arbitrage (as r=0) by investing (or short selling according to the sign of$\mu$) at the time where$\sigma$is null, or if you prefer as soon as$t$is in$B\$ (which is not a Lebesgue negligible set by hypothesis) which is absurd as no-arbitrage holds. The details that remain to be proved is that ...

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Time-series regression is not a great method for determining betas on individual securities. Rather, the most common method used by the commercial risk model providers is called "predicted beta" or "fundamental beta." The leader in this area is Barra. The way they define the predicted beta, it appears that they include the constant in the regression.

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