A Cautionary Note on the Put-Call Parity under an Asset Pricing Model with a Lower Reflecting Barrier
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Authors
Hertrich, Markus
Author (Corporation)
Publication date
09.2015
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Type
01A - Journal article
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Parent work
Swiss Journal of Economics and Statistics
Special issue
DOI of the original publication
Series
Series number
Volume
151
Issue / Number
3
Pages / Duration
227-260
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Publisher / Publishing institution
Springer
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Edition
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Abstract
The put-call parity is free from distributional assumptions. It is tempting to assume that this parity also holds when an asset pricing model includes reflecting barriers. This paper shows that in the case of geometric Brownian motion with reflection such barriers cause the standard put-call parity to differ from the riskneutral parity. This paper then analyzes the error that arises when the diffusion is bounded and the standard put-call parity is applied in a risk-neutral framework as a shortcut to impute put prices from call prices, and vice versa. The risk-neutral parity that is derived for a reflected geometric Brownian motion is then used to analyze the impact that the Swiss National Bank’s minimum exchange rate regime vis-à-vis the euro has had on foreign exchange hedging costs. The analysis shows that in the analyzed period domestic investors may have incurred substantial costs as a result of hedging exposure to the euro currency and may have been overexposed to foreign exchange risk.
Keywords
Euro/Swiss franc floor, hedging, put-call parity, reflected geometric Brownian motion, risk-neutral parity
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ISBN
ISSN
0303-9692
1421-2110
2673-2777
2235-6282
1421-2110
2673-2777
2235-6282
Language
English
Created during FHNW affiliation
No
Strategic action fields FHNW
Publication status
Published
Review
Peer review of the complete publication
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License
Citation
Hertrich, M. (2015). A Cautionary Note on the Put-Call Parity under an Asset Pricing Model with a Lower Reflecting Barrier. Swiss Journal of Economics and Statistics, 151(3), 227–260. http://hdl.handle.net/11654/6242