 Stochastic arbitrage with market index optionsBrendan K. Beare, Juwon Seo and Zhongxi Zheng Journal of Banking & Finance, 2025, vol. 173, issue C Abstract: Opportunities for stochastic arbitrage in an options market arise when it is possible to construct a portfolio of options which provides a positive option premium and which, when combined with a direct investment in the underlying asset, generates a payoff which stochastically dominates the payoff from the direct investment in the underlying asset. We provide linear and mixed-integer linear programs for computing the stochastic arbitrage opportunity providing the maximum option premium to an investor. We apply our programs to 18 years of data on monthly put and call options on the Standard & Poors 500 index, finding no evidence that stochastic arbitrage opportunities are systematically present. A skewed specification of the underlying market return distribution with a constant market risk premium and constant multiplicative variance risk premium is broadly consistent with the pricing of market index options at moderate strikes. Keywords: Linear program; Mixed-integer linear program; Option mispricing; Portfolio choice; Pricing kernel puzzle; Stochastic arbitrage; Stochastic dominance (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:173:y:2025:i:c:s0378426625000160 DOI: 10.1016/j.jbankfin.2025.107395 Access Statistics for this article Journal of Banking & Finance is currently edited by Ike Mathur More articles in Journal of Banking & Finance from Elsevier |
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