Thursday, January 15, 2009

No Arb (Free Lunch) Joke

In the joke that a student tells a prof. that there is a bill on the ground and the prof replies that it is not possible is it self a joke.
If the arb opportunities are not arbitraged away by agents then such opportunity would not cease to exist. This is because when some one sees money on the street they pick than but may be not coins of lower denomination. If this does not happen than there would be “free lunches” just lying around and not being utilised.
Suminda Sirinath Salpitikorala Dharmasena


Wednesday, January 07, 2009

Thoughts on Hedging Illiquid Assets (Hedging Under Liquidity Constraints)

An option price is the cost of hedging the contingent claim during its life. But when liquidity is scares, and buying stocks would influence the price, there would be cost in terms of the cost of slippage and miss hedges which would influence the price.
The cost of creating the replicating portfolio would be the price of the option. If the hedging is done using a particular strategy then the options should be the cost of hedging the option position using the particular strategy.
Suminda Sirinath Salpitikorala Dharmasena