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On the foundations of Lévy finance. Equilibrium for a single-agent financial market with jumps

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  • Herzberg, Frederik

    (Center for Mathematical Economics, Bielefeld University)

Abstract

For a continuous-time financial market with a single agent, we establish equilibrium pricing formulae under the assumption that the dividends follow an exponential Lévy process. The agent is allowed to consume a lump at the terminal date; before, only flow consumption is allowed. The agent's utility function is assumed to be additive, defined via strictly increasing, strictly concave smooth felicity functions which are bounded below (thus, many CRRA and CARA utility functions are included). For technical reasons we require that only pathwise continuous trading strategies are permitted in the demand set. The resulting equilibrium prices depend on the agent's risk-aversion through the felicity functions. It turns out that these prices will be the (stochastic) exponential of a Lévy process essentially only if this process is geometric Brownian motion.

Suggested Citation

  • Herzberg, Frederik, 2011. "On the foundations of Lévy finance. Equilibrium for a single-agent financial market with jumps," Center for Mathematical Economics Working Papers 406, Center for Mathematical Economics, Bielefeld University.
  • Handle: RePEc:bie:wpaper:406
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    File URL: https://pub.uni-bielefeld.de/download/2315962/2319848
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    References listed on IDEAS

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    1. Nigel J. Cutland & Ekkehard Kopp & Walter Willinger, 1993. "From Discrete to Continuous Financial Models: New Convergence Results For Option Pricing," Mathematical Finance, Wiley Blackwell, vol. 3(2), pages 101-123.
    2. Merton, Robert C., 1976. "Option pricing when underlying stock returns are discontinuous," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 125-144.
    3. Khan, M. Ali & Sun, Yeneng, 2001. "Asymptotic Arbitrage and the APT with or without Measure-Theoretic Structures," Journal of Economic Theory, Elsevier, vol. 101(1), pages 222-251, November.
    4. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics,in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
    5. Bick, Avi, 1990. " On Viable Diffusion Price Processes of the Market Portfolio," Journal of Finance, American Finance Association, vol. 45(2), pages 673-689, June.
    6. Herzberg, Frederik, 2011. "Linear hyperfinite Lévy integrals," Center for Mathematical Economics Working Papers 404, Center for Mathematical Economics, Bielefeld University.
    7. Cox, John C & Ingersoll, Jonathan E, Jr & Ross, Stephen A, 1985. "An Intertemporal General Equilibrium Model of Asset Prices," Econometrica, Econometric Society, vol. 53(2), pages 363-384, March.
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    Keywords

    Asset pricing; Financial equilibrium; Lévy processes; Representative agent models; Nonstandard analysis;

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