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Arbitrage Opportunities in Arbitrage-Free Models of Bond Pricing

Backus, David K. et al.
NYU Faculty Digital Archive · Papers
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We explore the practitioners’ methodology of choosing time-dependent parameters to fit a bond model to selected asset prices, and show that it can lead to systematic mispricing of some assets. The Black-Derman-Toy model, for example, is likely to overprice call options on long bonds when interest ra
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