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From: Craig Nelson
Affiliation:
Address: tbonds@viconet.com
Date: 21 Jul 1998
Time: 17:15:59
I was posed an interesting question regarding option pricing vis-a-vis put/call parity. More specifically, does convexity affect bond calls and puts? For example, we know that most fixed income securities (without optionality) exhibit positive convexity. This means that for a given increase/decrease in rates (say 10 bps) you will make more in relative/absolute terms when rates drop than you will lose when rates increase, assuming you have a long position in the Bond. The reverse would be true for a short position.
Wouldn't this imply that Bond calls should be priced higher than Bond puts since you would make more for a given drop in the level of interest rates (due to the convexity of the underlying bond), than you would make on a Bond put for a same-magnitude increase in the level of interest rates? Wouldn't this violate Put/Call Parity?
Regards,
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