Critical transaction costs and 1-step asymptotic arbitrage in fractional binary markets

DOI10.1142/S0219024915500296zbMATH Open1337.91159arXiv1407.8068MaRDI QIDQ2947342FDOQ2947342

Authors: Fernando Cordero, Lavinia Perez-Ostafe 

Publication date: 22 September 2015

Published in: International Journal of Theoretical and Applied Finance (Search for Journal in Brave)

Abstract: We study the arbitrage opportunities in the presence of transaction costs in a sequence of binary markets approximating the fractional Black-Scholes model. This approximating sequence was constructed by Sottinen and named fractional binary markets. Since, in the frictionless case, these markets admit arbitrage, we aim to determine the size of the transaction costs needed to eliminate the arbitrage from these models. To gain more insight, we first consider only 1-step trading strategies and we prove that arbitrage opportunities appear when the transaction costs are of order $o(1/sqrtN)$. Next, we characterize the asymptotic behavior of the smallest transaction costs $lambd{a}_c^{(N)}$, called "critical" transaction costs, starting from which the arbitrage disappears. Since the fractional Black-Scholes model is arbitrage-free under arbitrarily small transaction costs, one could expect that $lambd{a}_c^{(N)}$ converges to zero. However, the true behavior of $lambd{a}_c^{(N)}$ is opposed to this intuition. More precisely, we show, with the help of a new family of trading strategies, that $lambd{a}_c^{(N)}$ converges to one. We explain this apparent contradiction and conclude that it is appropriate to see the fractional binary markets as a large financial market and to study its asymptotic arbitrage opportunities. Finally, we construct a $1$-step asymptotic arbitrage in this large market when the transaction costs are of order $o(1/N^H)$, whereas for constant transaction costs, we prove that no such opportunity exists.

Full work available at URL: https://arxiv.org/abs/1407.8068

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zbMATH Keywords

fractional Brownian motionfractional binary marketstransaction costsarbitrage

Mathematics Subject Classification ID

Fractional processes, including fractional Brownian motion (60G22) Microeconomic theory (price theory and economic markets) (91B24) Actuarial science and mathematical finance (91G99)

Cites Work

• Asymptotic arbitrage in large financial markets
• Arbitrage in fractional Brownian motion models
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• A quantitative and a dual version of the Halmos-Savage theorem with applications to mathematical finance
• BINARY MARKETS UNDER TRANSACTION COSTS
• Arbitrage with Fractional Brownian Motion
• Fractional processes as models in stochastic finance
• Fractional Brownian motion, random walks and binary market models
• The fundamental theorem of asset pricing for continuous processes under small transaction costs
• Stock market prices and long-range dependence
• Asymptotic arbitrage in large financial markets with friction

Cited In (3)

• Synchronization analysis of fractional order delayed BAM neural networks via multi-delay-boundary inequality
• Strong asymptotic arbitrage in the large fractional binary market
• Asymptotic arbitrage in fractional mixed markets

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