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Empty Promises and Arbitrage

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  • Willard, Gregory A
  • Dybvig, Philip H

Abstract

Analysis of absence of arbitrage normally ignores payoffs in states to which the agent assigns zero probability. We extend the fundamental theorem of asset pricing to the case of 'no empty promises' in which the agent cannot promise arbitrarily large payments in some states. There is a superpositive pricing rule that can assign positive price to claims in zero probability states important to the market as well as assigning positive prices to claims in the states of positive probability. With continuous information arrival, no empty promises can be enforced by shutting down the agent's subsequent investments once wealth hits zero. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Willard, Gregory A & Dybvig, Philip H, 1999. "Empty Promises and Arbitrage," The Review of Financial Studies, Society for Financial Studies, vol. 12(4), pages 807-834.
    • Handle: RePEc:oup:rfinst:v:12:y:1999:i:4:p:807-34
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    Cited by:

    1. Jun Liu, 2004. "Losing Money on Arbitrage: Optimal Dynamic Portfolio Choice in Markets with Arbitrage Opportunities," The Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 611-641.
    2. Patrick Beissner, 2019. "Coherent-Price Systems and Uncertainty-Neutral Valuation," Risks, MDPI, vol. 7(3), pages 1-18, September.
    3. Jaime A. Londo~no, 2003. "State Tameness: A New Approach for Credit Constrains," Papers math/0305274, arXiv.org, revised Feb 2004.
    4. Sergey Iskoz & Jiang Wang, 2003. "How to Tell if a Money Manager Knows More?," NBER Working Papers 9791, National Bureau of Economic Research, Inc.
    5. Weidong Tian & Junya Jiang & Weidong Tian, 2017. "Model Uncertainty Effect on Asset Prices," International Review of Finance, International Review of Finance Ltd., vol. 17(2), pages 205-233, June.
    6. Larry G. Epstein & Shaolin Ji, 2013. "Ambiguous Volatility and Asset Pricing in Continuous Time," The Review of Financial Studies, Society for Financial Studies, vol. 26(7), pages 1740-1786.

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