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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27155
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| Title: | Arbitrage Opportunities in Arbitrage-Free Models of Bond Pricing |
| Authors: | Backus, David K.
Foresi, Silverio
Zin, Stanley E. |
| Keywords: | bond prices and yields
forward rates
time-dependent drift and volatility
options |
| Issue Date: | 25-Oct-1994 |
| Series/Report no.: | FIN-94-005 |
| Abstract: | We explore the practitioners’ methodology of choosing
time-dependent parameters to fit a bond model to selected asset prices,
and show that it can lead to systematic mispricing of some assets. The
Black-Derman-Toy model, for example, is likely to overprice call options
on long bonds when interest rates exhibit mean reversion. This
mispricing can be exploited, even when no other traders offer the
mispriced assets. We argue more generally that time-dependent parameters
cannot substitute for sound fundamentals. |
| URI: | http://hdl.handle.net/2451/27155 |
| Appears in Collections: | Finance Working Papers
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