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Question 6 (16 marks) a) It has been observed that the put-call parity relation is often violated in practice that is, Put price > Synthetic
Question 6 (16 marks) a) It has been observed that the put-call parity relation is often violated in practice that is, Put price > Synthetic put price = Call price + Present value of strike price - Underlying stock price + Present value of dividends. In other words, if one buys the synthetic put by buying call, buying a risk-less bond that pays the strike price at the maturity, and short-selling the underlying stock and sells the put with the same strike price as the call option, she can make an arbitrage profit. Name TWO market frictions that would limit arbitrageurs from profiting from put-call parity violations and briefly explain. (4 marks) Question 6 (16 marks) a) It has been observed that the put-call parity relation is often violated in practice that is, Put price > Synthetic put price = Call price + Present value of strike price - Underlying stock price + Present value of dividends. In other words, if one buys the synthetic put by buying call, buying a risk-less bond that pays the strike price at the maturity, and short-selling the underlying stock and sells the put with the same strike price as the call option, she can make an arbitrage profit. Name TWO market frictions that would limit arbitrageurs from profiting from put-call parity violations and briefly explain. (4 marks)
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