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Stochastic dominance option bounds and Nth order arbitrage opportunities

Research output: Working paper

Published
Publication date2004
Place of PublicationLancaster University
PublisherThe Department of Accounting and Finance
Original languageEnglish

Publication series

NameAccounting and Finance Working Paper Series

Abstract

In this paper we first derive Nth order stochastic dominance option bounds from concurrently expiring options. We show that these bounds are given by pricing kernels that have piecewise constant (N - 2)th derivatives. When these option bounds are violated there are Nth order arbitrage opportunities interpreted as (weighted average) conditional expected return comparison. We then establish a way to explore these arbitrage opportunities in option markets.