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rbitrage Free Price Bounds for Property Derivatives

June 9 2009

J. Syz, Zurich Cantonal Bank, and P. Vanini, Swiss Finance Institute.1

bstract

Market frictions inhibit perfect replication of property derivatives and de ne the property spread

as a price measure in the incomplete real estate market. We identify transaction costs, transaction

time and short sale constraints as the main frictions in this market. Based on these frictions, we

set up a framework of arbitrage free price bounds for property derivatives. In turn, we use observed

derivative prices to determine the implied cost of the frictions. Finally, we verify these values using

other research and so con rm the accuracy of our framework.

JEL Classification: G10, G12

Keywords: Property Derivatives; Property Spread; Arbitrage Free Price Bounds; Mar ket Frictions; Halifax House Price Index

Acknowledgement: This research has been carried out within (the project on ”Credit Risk and Non-standard sources of risk in finance”) the National Centre of Competence in Research ”Financial Valuation and Risk Management” (NCCR FINRISK). The NCCR FINRISK is a research instrument of the Swiss National Science Foundation.”

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