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Fundamental theorem of asset pricing with acceptable risk in markets with frictions

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  • Maria Arduca
  • Cosimo Munari

Abstract

We study the range of prices at which a rational agent should contemplate transacting a financial contract outside a given securities market. Trading is subject to nonproportional transaction costs and portfolio constraints and full replication by way of market instruments is not always possible. Rationality is defined in terms of consistency with market prices and acceptable risk thresholds. We obtain a direct and a dual description of market-consistent prices with acceptable risk. The dual characterization requires an appropriate extension of the classical Fundamental Theorem of Asset Pricing where the role of arbitrage opportunities is played by good deals, i.e., costless investment opportunities with acceptable risk-reward tradeoff. In particular, we highlight the importance of scalable good deals, i.e., investment opportunities that are good deals regardless of their volume.

Suggested Citation

  • Maria Arduca & Cosimo Munari, 2020. "Fundamental theorem of asset pricing with acceptable risk in markets with frictions," Papers 2012.08351, arXiv.org, revised Apr 2022.
    • Handle: RePEc:arx:papers:2012.08351
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    Cited by:

    1. Maria Arduca & Cosimo Munari, 2021. "Risk measures beyond frictionless markets," Papers 2111.08294, arXiv.org.

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