Replication, Synthetics, and Arbitrage

Obiyathulla Bacha and Pattarake Sarajoti

Chapter 10 in Financial Derivatives:Markets and Applications, 2023, pp 381-404 from World Scientific Publishing Co. Pte. Ltd.

Abstract: This chapter is designed to introduce synthetics and arbitrage and to explore in depth the put–call parity relationship. The chapter shows why these equilibrium relationships must hold and how arbitrage is possible when there is a disequilibrium. The possibility of arbitrage helps to ensure that equilibrium relationships hold. The chapter also shows how arbitrage can bring prices back into equilibrium. On completing the chapter you should have a good understanding of the role arbitrage plays in ensuring market efficiency. You should also appreciate how the flexibility of options enable the synthetization of assets making riskless arbitrage possible.

Keywords: Derivatives; Financial Derivatives; Derivative Markets; Forwards; Futures; Options; Shariah Compliant Derivatives; Islamic Derivatives (search for similar items in EconPapers)
JEL-codes: G1 G10 G11 (search for similar items in EconPapers)
Date: 2023
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