%0 Journal Article
%T Arbitrage Opportunities in Misspecified Stochastic volatility Models
%A Rudra P. Jena
%A Peter Tankov
%J Quantitative Finance
%D 2010
%I arXiv
%X There is vast empirical evidence that given a set of assumptions on the real-world dynamics of an asset, the European options on this asset are not efficiently priced in options markets, giving rise to arbitrage opportunities. We study these opportunities in a generic stochastic volatility model and exhibit the strategies which maximize the arbitrage profit. In the case when the misspecified dynamics is a classical Black-Scholes one, we give a new interpretation of the classical butterfly and risk reversal contracts in terms of their (near) optimality for arbitrage strategies. Our results are illustrated by a numerical example including transaction costs.
%U http://arxiv.org/abs/1002.5041v3