Regulatory Arbitrage using Put-Call Parity

11 Pages Posted: 20 Aug 2005  

Michael S. Knoll

University of Pennsylvania Law School; University of Pennsylvania - Real Estate Department

Abstract

The conflict between appearance and reality often arises in the law, where it is usually cast as pitting the substance of a transaction against its form. That conflict also arises in finance in the form of the put-call parity theorem, which states that given any three of the following four financial instruments: 1) a riskless zero coupon bond, 2) a share of stock, 3) a call option on the stock, and 4) a put option on the stock - the fourth instrument can be replicated. Thus, the theorem implies that any financial position containing any of those four instruments can be constructed in at least two different ways. Its legal significance arises when economically equivalent holdings receive different legal treatments because they are constructed from different instruments. This article provides several examples of how put-call parity has been used to engage in regulatory arbitrage and discusses the significance of such arbitrage for regulatory policy.

JEL Classification: G18, G39, H26, K29, L59, N40

Suggested Citation

Knoll, Michael S., Regulatory Arbitrage using Put-Call Parity. Journal of Applied Finance, Vol. 15, No. 1, Spring/Summer 2005. Available at SSRN: https://ssrn.com/abstract=780727

Michael S. Knoll (Contact Author)

University of Pennsylvania - Real Estate Department ( email )

Philadelphia, PA 19104-6330
United States

University of Pennsylvania Law School ( email )

3501 Sansom Street
Philadelphia, PA 19104
United States
215-898-6190 (Phone)
215-573-2025 (Fax)

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