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Market Forces and Dynamic Asset Pricing

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Author Info
Goran Peskir
Jamsheed Shorish () (Department of Economics, University of Aarhus, Denmark)

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Abstract

We study a dynamic model of asset pricing which is driven by two characteristic market features: the law of investor demand (e.g. 'buy low, sell high') and the law of the market institution (which codifies the trading rules under which the market operates). We demonstrate in a simple investor-specialist trading market that these features are sufficient to guarantee an equilibrium where investors' trading strategies and the specialist's rule of price adjustments are best responses to each other. The drift term appearing in the resulting equation of the asset price process may be interpreted using Newtonian mechanics as the acceleration of a 'market force'. If either of the market participants is risk-neutral, the result leads to risk-neutral asset pricing (e.g. the Black and Scholes option pricing formula).

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Publisher Info
Paper provided by School of Economics and Management, University of Aarhus in its series Economics Working Papers with number 1999-13.

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Handle: RePEc:aah:aarhec:1999-13

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Related research
Keywords: Market microstructure; asset pricing; market force; inertial frame of reference; accelerated frame of reference; (geometric) Brownian motion; Newtonian mechanics; Smoluchowski's approximation; optimal stochastic control; the Hamilton-Jacobi-Bellman equation; Markov property; Ornstein-Uhlenbeck process; Lévy process;

Find related papers by JEL classification:
C60 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - General
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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