Explore Single-Period Asset Arbitrage
This example explores basic arbitrage concepts in a single-period, two-state asset portfolio. The portfolio consists of a bond, a long stock, and a long call option on the stock.
It uses these Symbolic Math Toolbox™ functions:
equationsToMatrix
to convert a linear system of equations to a matrix.linsolve
to solve the system.Symbolic equivalents of standard MATLAB® functions, such as
diag
.
这个例子symbolically derives the risk-neutral probabilities and call price for a single-period, two-state scenario.
Define Parameters of the Portfolio
Create the symbolic variabler
representing the risk-free rate over the period. Set the assumption thatr
is a positive value.
symsrpositive
Define the parameters for the beginning of a single period,time = 0
. HereS0
is the stock price, andC0
is the call option price with strike,K
.
symsS0C0Kpositive
Now, define the parameters for the end of a period,time = 1
. Label the two possible states at the end of the period as U (the stock price over this period goes up) and D (the stock price over this period goes down). Thus,SU
andSD
are the stock prices at states U and D, andCU
is the value of the call at state U. Note that
.
symsSUSDCUpositive
The bond price attime = 0
is 1. Note that this example ignores friction costs.
Collect the prices attime = 0
into a column vector.
prices = [1 S0 C0]'
prices =
Collect the payoffs of the portfolio attime = 1
into thepayoff
matrix. The columns ofpayoff
correspond to payoffs for states D and U. The rows correspond to payoffs for bond, stock, and call. The payoff for the bond is1 + r
. The payoff for the call in state D is zero since it is not exercised (because
).
payoff = [(1 + r), (1 + r); SD, SU; 0, CU]
payoff =
CU
is worth苏- K
in state U. Substitute this value inpayoff
.
payoff = subs(payoff, CU, SU - K)
payoff =
Solve for Risk-Neutral Probabilities
Define the probabilities of reaching states U and D.
symspUpDreal
Under no-arbitrage,eqns == 0
must always hold true with positivepU
andpD
.
eqns = payoff*[pD; pU] - prices
eqns =
Transform equations to userisk-neutralprobabilities.
symspDrnpUrnreal; eqns = subs(eqns, [pD; pU], [pDrn; pUrn]/(1 + r))
eqns =
The unknown variables arepDrn
,pUrn
, andC0
. Transform the linear system to a matrix form using these unknown variables.
[A, b] = equationsToMatrix(方程式,[pDrn pUrn, C0]”)
A =
b =
Usinglinsolve
, find the solution for the risk-neutral probabilities and call price.
x = linsolve(A, b)
x =
Verify the Solution
Verify that under risk-neutral probabilities,x(1:2)
, the expected rate of return for the portfolio,E_return
equals the risk-free rate,r
.
E_return = diag(prices)\(payoff - [prices,prices])*x(1:2); E_return = simplify(subs(E_return, C0, x(3)))
E_return =
Test for No-Arbitrage Violations
As an example of testing no-arbitrage violations, use the following values:r = 5%
,S0 = 100
, andK = 100
. ForSU < 105
, the no-arbitrage condition is violated becausepDrn = xSol(1)
is negative (SU >= SD
). Further, for any call price other thanxSol(3)
, there is arbitrage.
xSol = simplify(subs(x, [r,S0,K], [0.05,100,100]))
xSol =
Plot Call Price as a Surface
Plot the call price,C0 = xSol(3)
, for50 <= SD <= 100
and105 <= SU <= 150
. Note that the call is worth more when the "variance" of the underlying stock price is higher for example,SD = 50, SU = 150
.
fsurf(xSol(3), [50,100,105,150]) xlabelSDylabelSUtitle'Call Price'
Reference
Advanced Derivatives, Pricing and Risk Management: Theory, Tools and Programming Applications
by Albanese, C., Campolieti, G.