The aim of this paper is to discuss the no-arbitrage condition in option implied trees based on forward induction and to propose a no-arbitrage test that rules out the negative probabilities problem and hence enhances the pricing performance. The no-arbitrage condition takes into account two main features: the position of the node in the tree and the relation between the dividend yield and the risk-free rate. The proposed methodology is tested in and out of sample with Italian index options data and findings support a good pricing performance.
On the no arbitrage condition in option implied trees / V., Moriggia; Muzzioli, Silvia; Torricelli, Costanza. - In: EUROPEAN JOURNAL OF OPERATIONAL RESEARCH. - ISSN 0377-2217. - STAMPA. - 193:(2009), pp. 212-221. [10.1016/j.ejor.2007.10.017]
On the no arbitrage condition in option implied trees
MUZZIOLI, Silvia;TORRICELLI, Costanza
2009-01-01
Abstract
The aim of this paper is to discuss the no-arbitrage condition in option implied trees based on forward induction and to propose a no-arbitrage test that rules out the negative probabilities problem and hence enhances the pricing performance. The no-arbitrage condition takes into account two main features: the position of the node in the tree and the relation between the dividend yield and the risk-free rate. The proposed methodology is tested in and out of sample with Italian index options data and findings support a good pricing performance.
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