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Arbitrage Restrictions Across Financial Markets: Theory, Methodology and Tests

Bossaerts, Peter and Hillion, Pierre (1991) Arbitrage Restrictions Across Financial Markets: Theory, Methodology and Tests. Social Science Working Paper, 751. California Institute of Technology , Pasadena, CA. (Unpublished)

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The Cox, Ingersoll and Ross [1985a] general equilibrium model is extended by allowing the representative investor to trade in a batch call option market with execution price uncertainty. Necessary restrictions on the execution price uncertainty for the original equilibrium to remain intact are derived. They take the form of moment conditions in the pricing error (defined as the difference between the observed call price and the theoretical call price that would obtain in the absence of execution price uncertainty). The moment conditions can easily be estimated and tested using a version of the Method of Simulation Moments (MSM). In it, simulation estimates, obtained by discretely approximating the risk-neutral processes of the underlying stock price and the interest rate, are substituted for analytically unknown call prices. The asymptotics and other aspects of the MSM estimator are discussed. The model is tested on transaction prices from the Berkeley Options Data Base.

Item Type:Report or Paper (Working Paper)
Bossaerts, Peter0000-0003-2308-2603
Additional Information:Revised version. Original dated to November 1990. This paper combines and extends results reported in earlier working papers of ours. Comments from several colleagues are gratefully acknowledged. We remain responsible, however, for any remaining mistakes. We thank Carnegie Mellon University and INSEAD for financial support, and the JPL/Caltech Supercomputing Project for computing support.
Errata:Equation cross-references corrected May 1991.
Group:Social Science Working Papers
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Carnegie Mellon UniversityUNSPECIFIED
Series Name:Social Science Working Paper
Issue or Number:751
Record Number:CaltechAUTHORS:20170831-143858811
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Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:81039
Deposited By: Jacquelyn Bussone
Deposited On:31 Aug 2017 22:34
Last Modified:03 Oct 2019 18:37

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