Questions tagged [arbitrage]

The simultaneous purchase and sale of a financial security in order to profit from the difference in the security price during the trading activity.

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45
votes
4answers
6k views

How much data is needed to validate a short-horizon trading strategy?

Suppose one has an idea for a short-horizon trading strategy, which we will define as having an average holding period of under 1 week and a required latency between signal calculation and execution ...
25
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1answer
3k views

How do different methods and techniques used in pairs trading compare?

I was going through the paper of Avellaneda (2008) on stat arb and I found it interesting that he uses asset returns vs. their respective ETFs to compute the s-score. I am wondering if anyone has ...
22
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3answers
2k views

How can an ETF outperform its benchmark index?

Deutsche Bank’s ETF platform, db X-trackers, provides a rather remarkable ETF tracking Euro Stoxx 50 (which is the most widely used regional blue-chip index in Europe). What makes it remarkable is ...
22
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2answers
2k views

Why isn't the Nelson-Siegel model arbitrage-free?

Assume $X_t$ is a multivariate Ornstein-Uhlenbeck process, i.e. $$dX_t=\sigma dB_t-AX_tdt$$ and the spot interest rate evolves by the following equation: $$r_t=a+b\cdot X_t.$$ After solving for $X_t$ ...
19
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4answers
12k views

Is statistical arbitrage on FX possible?

Do you know of any papers which consider pairs trading (or statistical arbitrage) on foreign exchange? I couldn't find any. I asked this question on several forums and got no reply. Thus, I guess ...
17
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1answer
2k views

statistical arbitrage vs factor trading

I've recently read Avellaneda & Lee which seems to be widely recommended as an introduction to Statistical Arbitrage methods in trading. For those who aren't familiar with the paper, the method in ...
14
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3answers
11k views

Volatility arbitrage - how is the profit extracted?

Is there any paper that describes in detail how the profit is extracted in directional volatility bet (vol arb)? I mean in the case that I bet the realized volatility will be lower than currently ...
14
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2answers
4k views

SPX options vs VIX futures trading

Forward volatility implied by SPX options, and that of VIX futures get out of line. If there existed VIX SQUARED futures they could easily be replicated (and arbitraged) with a strip of SPX options. ...
11
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5answers
1k views

When to shut down a trend following strategy?

Suppose I have trend following strategy(on close to close data) that is not getting acceptable returns for some time. When should I start thinking about shutting it down?
11
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1answer
8k views

Implied dividend estimation

I am looking at two different ways of estimating the expected / implied dividends from market data. 1. Dividend futures I know that this asset class is not very liquid and might not be ...
11
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1answer
611 views

calculating arbitrage-free ranges based off outright, spread, and fly prices

This may be more applied math rather than finance focused, but I'm curious about using linear algebra techniques for generating possible arbitrage signals among outright instruments and spreads/flies ...
10
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3answers
7k views

How to exploit calendar arbitrage?

Say we are looking at European Call options in a toy environment with zero deterministic interest rates, a stock paying no dividends, no repo rates etc... Let $C(T,K)$ be the price of a call with ...
10
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1answer
2k views

What is the average Sharpe ratio of volatility arbitrage funds?

Where can I get data on performance metrics for volatility arbitrage funds? I am trying to compare the Sharpe ratio of my strategy to those of the major players.
9
votes
1answer
3k views

Arbitrage opportunity interview question

I have seen this interview question mentioned in a couple of places: There are three call options on the market, with the same expiry and with strikes 10, 20, and 30. Suppose the call option with ...
9
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1answer
1k views

What is the difference between market efficiency, market equilibrium, and no-arbitrage?

Aaron Brown (in the book, The Poker Face of Wall Street, p. 196), discusses four approaches to deriving the same Black-Scholes-Merton option-pricing formula: Ed Thorp, Myron Scholes, Robert Merton, ...
9
votes
1answer
801 views

USDCAD options vs CADUSD options arbitrage?

I think I've found an arbitrage opportunity. Right now, I can do this (first via CME, second via SAXO) : BUY CADUSD AMERICAN PUT 10200 STRIKE EXPIRING 16 MAR 2011 FOR 53 pips USD SELL USDCAD ...
8
votes
1answer
12k views

Call option arbitrage opportunity

I am having trouble wrapping my head around some text provided to us by our lecturer (unfortunately he is currently unavailable). If we let $c$ be the price of a European call option, $S_0$ the ...
8
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2answers
2k views

How to check that an interest rate curve is arbitrage free

I have 2 interest rate curves (LIBOR 3M and OIS). I want to create stress scenarios for those two curves. Is it possible that some scenarios will make my term structure arbitrageable? How can I test ...
8
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2answers
276 views

Why won't Bjork ever show that the integrability condition is satisfied?

A major technique employed throughout Bjork's "Arbitrage theory in Continuous Time" is that when taking the expectation of a stochastic integral, the result is 0. This is based on a result presented ...
7
votes
6answers
2k views

Arbitrage possible with negative rate of interest?

Given a security having price $1$ at time $t=0$, and price $1+r$ in all world states at $t=T$, i.e., a risk-free bond with interest rate $r$. At $t=0$, short this and also buy an other risk-free bond. ...
7
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1answer
2k views

Arbitragefree Pricing: Q vs. P

I read that the Fundamental Theorem of Asset Pricing states, that a market is arbitrage-free if and only if there exists an equivalent martingale measure Q, under which the discounted asset price ...
7
votes
1answer
1k views

Profiting from price discrepancies between stock exchanges

Here is an interesting video by Nanex: http://www.youtube.com/watch?&v=rB5jJuMP84E Perhaps some of you have already seen something similar. It is an animation of the order routing. It shows 1/2 ...
7
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3answers
11k views

Why would a 6M LIBOR rate be significantly above 3M LIBOR, ED futures and swap rates?

Just was just looking at the various interest rates and noticed this: ...
7
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1answer
694 views

Where are creation unit baskets for ETFs published?

Where can the specification of a creation unit basket for an ETF be found? This information is needed for calculating the arbitrage possible between the ETF instrument itself and the creation unit ...
6
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2answers
622 views

What does put-call parity imply about option premiums?

We know that $$C-P = PV(F_{0,T}-K)$$ When we create a synthetic forward, we buy call and sell a put at the same strike price $K$. When we buy the call why do we assume the premium is positive? When ...
6
votes
1answer
200 views

Arbitrage with freshly issued bonds

I recently heard someone mention an arbitrage strategy involving selling freshly issued bonds and buying the "old batch" as it has shown that the liquidity in the fresh batch motivates/drives up these ...
6
votes
2answers
1k views

Does Black Scholes need to assume no arbitrage?

Since Girsanov's theorem guarantees a risk neutral measure for Geometric Brownian motion, by the fundamental theorem of asset pricing there can be no arbitrage. So, why does the model assume no ...
6
votes
1answer
2k views

Understanding Passive Rebate Arbitrage

I was reading a BMO paper which offered the following example of passive rebate arbitrage: "For example, if BBD.b is trading at $4.71 - ...
6
votes
2answers
381 views

Why is the LIBOR-market model free of arbitrage?

Recently I have been reading a lot on the market models. One thing that keeps escaping me - why is the Libor-market model (LMM) assumed to e free of aritrage in continuous time ? To me this means ...
6
votes
1answer
810 views

What research is available on the performance of convertible bond arbitrage models?

The basic principles of convertible bond arbitrage have been clear at least since Thorp and Kassouf (1967). For those who are not familiar, the arbitrage entails purchasing a convertible bond and ...
6
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0answers
315 views

What are the essential characteristics of asset prices?

I think the question has already been asked about stylized facts of asset returns; this question regards the essential characteristics and normative assumptions used to evaluate asset prices. I.e., ...
6
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0answers
199 views

Arbitrage free price of a derivative when the price is collected over the lifetime of the derivative

Let $X_t$ be an american style financial derivative with random exercise time $T$ where $t$ and $T$ belongs to some finite set $A$. Buying this derivative requires the buyer to pay $p_t$ up to time $T$...
5
votes
1answer
2k views

What is the pseudo code for a pairs trading strategy?

I am trying to learn about pairs trading strategy. I know that we have to long and short cointegrated assests simultaneously. But I still have some confusion in how the strategy works. I wrote the ...
5
votes
2answers
623 views

Pricing when arbitrage is possible through Negative Probabilities or something else

Assume that we have a general one-period market model consisting of $d+1$ assets and $N$ states. Using a replicating portfolio $\phi$, determine $\Pi(0;X)$, the price of a European call option, with ...
5
votes
1answer
2k views

Why must a riskless portfolio earn the risk-free rate?

In Options, Futures and Other Derivatives when Hull introduces the risk-neutral approach to pricing European options in the one-step binomial model, he claims that Riskless portfolio must, in the ...
5
votes
2answers
1k views

A few questions about signs of the Greek letters

Rho is the partial derivative of the value of call option, $C$, w.r.t the riskfree interest rate $r$: $$\rho \equiv \frac{\partial C}{\partial r}$$ In the standard B-S formula this term is positive, ...
5
votes
3answers
5k views

Arbitraging OANDA continuous rollover vs other brokers' discrete rollover

Most brokers compute rollover once a day (2200 GMT), but OANDA calculates it continuously. I thought I'd cleverly found an arbitrage opportunity, but it turns out OANDA knows about this and ...
5
votes
2answers
236 views

Why is $Y(t)V^h(t)$ a martingale?

Let $\lambda$ be the market price of risk: $\frac{a - r}{\sigma}$, and define $Y(t) = e^{-\lambda W(t) - (r + \frac{\lambda^2}{2})t}$. Let $V^h(t)$ be the value process of any self-financing portfolio....
5
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2answers
164 views

Two definitions of arbitrage in finite markets

I have read two definitions of the term an arbitrage opportunity in the literature*. Are they equivalent? Consider a single period market model over the measurable space $\Omega = \{\omega_1, \dots, \...
5
votes
1answer
414 views

Prove arbitrage opportunity

The continuously compounded interest rate is $r$. The current price of the underlying asset is $S(0)$ and the forward price with delivery time in 1 year is $F(0,1)$. Short selling of the stock ...
5
votes
1answer
1k views

Sufficient conditions for no static arbitrage

In Carr and Madan (2005), the authors give sufficient conditions for a set of call prices to arise as integrals of a risk-neutral probability distribution (See Breeden and Litzenberger (1978)), and ...
5
votes
2answers
775 views

What is model-free finance?

I have run across the term "model-free finance" (e.g. there was a Thalesian talk in London recently), yet haven't found any real definition of it nor anything really substantial. Could you point me ...
5
votes
1answer
79 views

market change, correlation and estimation bias

I hear many quants sating that markets change very slowly. This "fact" is even presented as a justification of statistical arbitrage, for example, by affirming that correlations remain roughly the ...
5
votes
1answer
239 views

Please explain this proof for me: (arbitrage and bounded set) [closed]

Consider this problem and subsequent proposition: Part of the proof of this proposition is given here: Could somebody please explain to me why the existence of the "associative ray" (which I have ...
5
votes
4answers
475 views

risk-neutral valuation implies no arbitrage?

It is known that in an arbitrage-free continuous time market, the price of every asset is evaluated as the corresponding price in the replicating strategy using risk-neutral valuation. I want to ...
5
votes
2answers
619 views

arbitrage in Heston model

Really struggling in this question: Consider a market with two assets $(B,S)$ whose price dynamics satisfy \begin{equation} dB_t = B_t r dt \end{equation} \begin{equation} \quad \quad \quad \quad \, ...
5
votes
1answer
1k views

Calculating most profitable arbitrage orders on multiple market with fixed and variable fees

If I have multiple markets (let's say 5, but the solution should be generic) trading the same stock/commodity/whatever, and the markets differ in both variable fees (which are in % of the trade order) ...
5
votes
0answers
329 views

Show that in an arbitrage-free and non-redundant market a certain set is compact

Some notation: We consider a financial market with $d+1$ assets, the $0$-th asset is considered the risk-free asset, the others are the risky ones. The vector $\overline \pi \in \mathbb R^{d+1}$ ...
4
votes
2answers
752 views

Why doesn't Black-Scholes assume the absence of statistical arbitrage?

Both Black-Scholes and binomial model assume that there's no risk-free arbitrage in the market. But that sounds like a very weak condition. If a trading scheme makes you gain 100 dollars with 99% ...
4
votes
1answer
933 views

Finding Arbitrage in two Puts

A European Put Option on a non-dividend paying stock with strike price 80 is currently priced at 8 and a put option on the same stock with strike price 90 is priced at 9. Is there an arbitrage ...

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