Stochastic arbitrage return and its implications for option pricing

The purpose of this work is to explore the role that arbitrage opportunities play in pricing financial derivatives. We use a non-equilibrium model to set up a stochastic portfolio, and for the random arbitrage return, we choose a stationary ergodic random process rapidly varying in time. We exploit the fact that option price and random arbitrage returns change on different time scales which allows us to develop an asymptotic pricing theory involving the central limit theorem for random processes. We restrict ourselves to finding pricing bands for options rather than exact prices. The resulting pricing bands are shown to be independent of the detailed statistical characteristics of the arbitrage return. We find that the volatility "smile" can also be explained in terms of random arbitrage opportunities.Comment: 14 pages, 3 fiqure

Proximity and gaze influences facial temperature:a thermal infrared imaging study

Direct gaze and interpersonal proximity are known to lead to changes in psycho-physiology, behaviour and brain function. We know little, however, about subtler facial reactions such as rise and fall in temperature, which may be sensitive to contextual effects and functional in social interactions. Using thermal infrared imaging cameras 18 female adult participants were filmed at two interpersonal distances (intimate and social) and two gaze conditions (averted and direct). The order of variation in distance was counterbalanced: half the participants experienced a female experimenter’s gaze at the social distance first before the intimate distance (a socially ‘normal’ order) and half experienced the intimate distance first and then the social distance (an odd social order). At both distances averted gaze always preceded direct gaze. We found strong correlations in thermal changes between six areas of the face (forehead, chin, cheeks, nose, maxilliary and periorbital regions) for all experimental conditions and developed a composite measure of thermal shifts for all analyses. Interpersonal proximity led to a thermal rise, but only in the ‘normal’ social order. Direct gaze, compared to averted gaze, led to a thermal increase at both distances with a stronger effect at intimate distance, in both orders of distance variation. Participants reported direct gaze as more intrusive than averted gaze, especially at the intimate distance. These results demonstrate the powerful effects of another person’s gaze on psycho-physiological responses, even at a distance and independent of context

Does the ECB Care about Shifts in Investors’ Risk Appetite?

A key problem facing monetary policy makers is determining whether serious financial instability is present. Periods of financial instability are linked with low investors’ risk appetite (or in other words high risk aversion). Two different measures of investors’ risk aversion are used: (a) the implied volatility from the Eurostoxx 50 index (VSTOX) and (b) an index based on principal component analysis applied to risk premia of several stock portfolios in the eurozone area (12 countries) with different fundamental and size characteristics. By using an unrestricted VAR model and impulse response analysis for the period January 1999 to August 2007, our results show that a shock in the risk aversion indicator affects negatively future real activity in the eurozone in a similar way to an exchange rate shock. The ECB reacts significantly to a risk aversion shock by reducing the interest rate in order to provide liquidity. Moreover, assuming rational expectations and using a forward-looking specification of the Taylor rule, we found that investors’ risk aversion affects the ECB behavior as the leading indicator of future economic activity but not as an independent argument for the monetary policy. It views price stability and economic and financial stability as highly complementary and mutually consistent objectives to be pursued within a unified policy framework.European Central Bank; monetary policy; Taylor rule; transmission mechanism; VAR model; GMM