Adjustment to Risk Free Rate/ Violation of Put-Call Parity

Saied Simozar

Abstract


The present value of a forward contract for any asset that does not pay a dividend is calculated by discounting its forward price by the risk-free rate. We show that the discount function for assets that have a non-zero correlation with interest rates, has to be adjusted to account for the correlation between the asset and interest rates. Put-Call parity is also violated and needs to be adjusted as well for such assets. It is shown that the risk-free rate is asset dependent. The adjustment to the price is small for short dated forwards, but increases quadratically with time to maturity.


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DOI: https://doi.org/10.11114/aef.v6i6.4521

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Applied Economics and Finance    ISSN 2332-7294 (Print)   ISSN 2332-7308 (Online)

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