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Closed-form solutions to static-arbitrage upper bounds on basket options

Javier Pena(jfp***at***andrew.cmu.edu)
Juan Vera(jvera***at***uwaterloo.ca)
Luis Zuluaga(lzuluaga***at***unb.ca)

Abstract: We provide a closed-form solution to the problem of computing the sharpest static-arbitrage upper bound on the price of a European basket option, given the prices of vanilla call options in the underlying securities. Unlike previous approaches to this problem, our solution technique is entirely based on linear programming. This also allows us to obtain an efficient (linear-size) linear programming formulation for the more realistic problem of computing sharp static arbitrage upper bounds taking into consideration bid-ask spreads in the given option prices and other transaction costs.

Keywords: arbitrage bounds, closed-form solutions, linear programming

Category 1: Applications -- OR and Management Sciences (Finance and Economics )

Category 2: Linear, Cone and Semidefinite Programming (Linear Programming )

Citation: Technical Report, Tepper School of Business, Carnegie Mellon University

Download: [PDF]

Entry Submitted: 07/25/2008
Entry Accepted: 07/25/2008
Entry Last Modified: 07/25/2008

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