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Benchmarking in two price financial markets

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  • Dilip B. Madan

    (University of Maryland)

Abstract

No arbitrage for two price economies with no locally risk free asset implies that suitably benchmarked prices are nonlinear martingales. However, both the benchmarking asset and the measure change depend on the process being benchmarked. Further assumptions allow the nonlinear martingales in discrete time to become expectations with respect to a nonadditivity probability. Such nonlinear expectations are imminently reasonable given the lack of experience with tail events on both sides of the gain loss spectrum. Continuous time extensions employ measure distortions. The general valuation of economic activities and the leveraging of stability in benchmarked price processes is then addressed. Traditional asset pricing questions and investigations are then reopened for benchmarked prices. In particular, the analytics for benchmarked option pricing and the asset pricing theory for benchmarked prices in a limiting stationary state are developed.

Suggested Citation

  • Dilip B. Madan, 2016. "Benchmarking in two price financial markets," Annals of Finance, Springer, vol. 12(2), pages 201-219, May.
    • Handle: RePEc:kap:annfin:v:12:y:2016:i:2:d:10.1007_s10436-016-0278-4
    DOI: 10.1007/s10436-016-0278-4
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    References listed on IDEAS

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    Cited by:

    1. Dilip B. Madan & Wim Schoutens & King Wang, 2017. "Measuring And Monitoring The Efficiency Of Markets," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(08), pages 1-32, December.
    2. Dilip B. Madan, 2018. "Financial equilibrium with non-linear valuations," Annals of Finance, Springer, vol. 14(2), pages 211-221, May.
    3. Dilip B. Madan & Martijn Pistorius & Wim Schoutens, 2017. "Conic Trading In A Markovian Steady State," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(02), pages 1-22, March.

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    More about this item

    Keywords

    Acceptable risks; Nonlinear expectations; Nonadditive probability; Distorted expectation;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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