Novel No-Arbitrage Conditions for Options Written on Defaultable Assets
Journal of Derivatives & Hedge Funds, Vol. 20, No. 4, 2014.
7 Pages Posted: 29 Jun 2014 Last revised: 24 Oct 2015
Date Written: June 26, 2014
Abstract
Based on the result of Orosi (2014), we derive an improved lower bound for European-style put options written on defaultable assets. Furthermore, we establish two additional no-arbitrage conditions, one for European-style puts and one for calls, which are tighter than the ones commonly reported in current literature. All of our results are based on static arbitrage arguments and have important implications for constructing arbitrage-free call or put option surfaces. In particular, we point out that the commonly stated conditions required for a call option surface are not always sufficient to generate an arbitrage-free call option surface.
Keywords: option, arbitrage, lower bounds, default, market efficiency
JEL Classification: G12, G13, G14
Suggested Citation: Suggested Citation
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