No-Arbitrage Bounds for Financial Scenarios

We derive no-arbitrage bounds for expected excess returns to generate scenarios used in financial applications. The bounds allow to distinguish three regions: one where arbitrage opportunities will never exist, a second where arbitrage may be present, and a third, where arbitrage opportunities will always exist. No-arbitrage bounds are derived in closed form for a given covariance matrix using the least possible number of scenarios. Empirical examples illustrate the practical potential of knowing these bounds. (authors' abstract)