Return of the portfolio:
Portfolio value in Up or Down Move/ Hedged Portfolio Value
If the portfolio value is positive, then there is an arbitrage opportunity:
- borrow the amount of the original portfolio
- interest is paid on the borrowed amount = 1 + rf
- buy the hedged portfolio
- next period, collect the portfoio return and reapy the loan on the hedged portfolio
Can someone explain this? Is the point here simply to hedge against down move in portfolio by buying the hedged portfolio?
