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Feasibility of riskless hedged portfolios in imperfect markets

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  • Hsinan Hsu
  • Yaw-Bin Wang

Abstract

The Black-Scholes model (1973) is developed under the concept of the riskless hedged portfolio by hedging the call option against the underlying stock. If the riskless hedged portfolio is feasible, investors' preference is independent of option pricing and the implied growth rate of stock price will be the riskless interest rate. Noticeably, the feasibility of this concept is based on the perfect market assumptions and no riskless arbitrage opportunity. However, none of the conditions of perfect capital markets is true in real capital markets. Therefore, whether the growth rate of the hedged portfolio is the riskless interest rate is an interesting and challenging topic. The purpose of this article is to provide a theoretical relationship between the return of the hedged portfolio and risk in imperfect markets. This theoretical foundation can be viewed as a supplementary work to Hsu and Wang (2004) and Wang and Hsu (2006).

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  • Hsinan Hsu & Yaw-Bin Wang, 2009. "Feasibility of riskless hedged portfolios in imperfect markets," Applied Economics Letters, Taylor & Francis Journals, vol. 16(11), pages 1149-1153.
    • Handle: RePEc:taf:apeclt:v:16:y:2009:i:11:p:1149-1153
    DOI: 10.1080/13504850701349161
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    References listed on IDEAS

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    1. Galai, Dan, 1977. "Tests of Market Efficiency of the Chicago Board Options Exchange," The Journal of Business, University of Chicago Press, vol. 50(2), pages 167-197, April.
    2. repec:bla:jfinan:v:44:y:1989:i:5:p:1289-1311 is not listed on IDEAS
    3. Hsinan Hsu & Janchung Wang, 2004. "Price Expectation and the Pricing of Stock Index Futures," Review of Quantitative Finance and Accounting, Springer, vol. 23(2), pages 167-184, September.
    4. Janchung Wang & Hsinan Hsu, 2006. "Degree of market imperfection and the pricing of stock index futures," Applied Financial Economics, Taylor & Francis Journals, vol. 16(3), pages 245-258.
    5. A. James Boness, 1964. "Elements of a Theory of Stock-Option Value," Journal of Political Economy, University of Chicago Press, vol. 72(2), pages 163-163.
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