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No-arbitrage bounds with transaction costs

November 1st, 2007

I recently contacted the author with a couple of questions regarding the no-arbitrage bounds with transaction costs derived on pages 138-139 in the DM textbook and he was kind enough to respond.  Basically, the formula derivations assume one price for the stock at time T.  That is natural for cash settlement, but not physical settlement where the arbitrager would be forced to trade at the bid and ask prices. (Even with cash settlement there can be some ambiguity about what price is being used to settle the transaction.)  The author is going to post a typo that he is assuming cash settlement.  In my sample exam, I also assume cash settlement.

I also asked about the sentence following formula 5.11 on page 139.  The author agreed it was confusing and it will be removed from further editions.  The author said he intended to imply that “the short rebate equaled the interest rate.”

James Errata

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