A hedge position should provide a(n) ______________ position in market equilibrium.

Question

Quizplus · Accepted Answer

Your option should be priced so that when it is combined with the stock in a hedged position, the return on the position equals the risk-free rate. To the extent that excess returns are available on a fully hedged position, people will have an incentive to take such positions. The impact of their transactions on relative prices will drive out any excess returns that might be earned. As a result, prices will adjust until the return on the hedged position is the same as the risk free rate and the option is neither overpriced nor underpriced.

A Hedge Position Should Provide A(n) ______________ Position in Market