Near-arbitrage opportunity in KOSPI200 index option market

Abstract

The purpose of this paper is to test whether there exist a near-arbitrage opportunity in KOSPI200 index option market due to the violation of good-deal bounds. The basic approach is to distinguish between mispriced options and fairly priced ones by good-deal bound, and then to compose zero-cost portfolios with these candidates, i.e., mispriced options, index futures and risk-free bond. To check Jensen’s alphas of these portfolios are significantly positive, I run regressions of log excess returns on the market excess return factor. As a result, Jensen’s alphas have positive value and are statistically significant at the level 1%. This indicates that using mispriced KOSPI200 index options leads to near-arbitrage opportunities.