Arbitrage Opportunities in Arbitrage-Free Models of Bond Pricing

David Backus, Silverio Foresi and Stanley Zin

Journal of Business & Economic Statistics, 1998, vol. 16, issue 1, 13-26

Abstract: Mathematical models of bond pricing are used by both academics and Wall Street practitioners, with practitioners introducing time-dependent parameters to fit 'arbitrage-free' models to selected asset prices. The authors show, in a simple one-factor setting, that the ability of such models to reproduce a subset of security prices need not extend to state-contingent claims more generally. They argue that the additional parameters of arbitrage-free models should be complemented by close attention to fundamentals, which might include mean reversion, multiple factors, stochastic volatility, and/or nonnormal interest-rate distributions.

Date: 1998
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Related works:
Working Paper: Arbitrage Opportunities in Arbitrage-Free Models of Bond Pricing (1996)
Working Paper: Arbitrage Opportunities in Arbitrage-Free Models of Bond Pricing (1996)
Working Paper: Arbitrage Opportunities in Arbitrage-Free Models of Bond Pricing (1994)
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