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Regulatory-Compliant Derivatives Pricing is Not Risk-Neutral

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  • Chris Kenyon
  • Andrew Green

Abstract

Regulations impose idiosyncratic capital and funding costs for holding derivatives. Capital requirements are costly because derivatives desks are risky businesses; funding is costly in part because regulations increase the minimum funding tenor. Idiosyncratic costs mean no single measure makes derivatives martingales for all market participants. Hence Regulatory-compliant pricing is not risk-neutral. This has implications for exit prices and mark-to-market.

Suggested Citation

  • Chris Kenyon & Andrew Green, 2013. "Regulatory-Compliant Derivatives Pricing is Not Risk-Neutral," Papers 1311.0118, arXiv.org, revised Aug 2014.
    • Handle: RePEc:arx:papers:1311.0118
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    References listed on IDEAS

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    1. Hiroaki Kaido & Halbert White, 2009. "Inference on Risk-Neutral Measures for Incomplete Markets," Journal of Financial Econometrics, Oxford University Press, vol. 7(3), pages 199-246, Summer.
    2. Tuckman, Bruce & Vila, Jean-Luc, 1992. "Arbitrage with Holding Costs: A Utility-Based Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1283-1302, September.
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