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Arbitrage and Control Problems in Finance. Presentation

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  • Elyès Jouini

    (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS - Centre National de la Recherche Scientifique - Université Paris Dauphine-PSL - PSL - Université Paris sciences et lettres)

Abstract

The theory of asset pricing takes its roots in the Arrow-Debreu model (see,for instance, Debreu 1959, Chap. 7), the Black and Scholes (1973) formula,and the Cox and Ross (1976) linear pricing model. This theory and its link to arbitrage has been formalized in a general framework by Harrison and Kreps (1979), Harrison and Pliska (1981, 1983), and Du¢e and Huang (1986). In these models, security markets are assumed to be frictionless: securities can be sold short in unlimited amounts, the borrowing and lending rates are equal, and there is no transaction cost. The main result is that the price process of traded securities is arbitrage free if and only if there exists some equivalent probability measure that transforms it into a martingale, when normalized by the numeraire. Contingent claims can then be priced by taking the expected value of their (normalized) payo§ with respect to any equivalent martingale measure. If this value is unique, the claim is said to be priced by arbitrage and it can be perfectly hedged (i.e. duplicated) by dynamic trading. When the markets are dynamically complete, there is only one such a and any contingent claim is priced by arbitrage. The of each state of the world for this probability measure can be interpreted as the state price of the economy (the prices of $1 tomorrow in that state of the world) as well as the marginal utilities (for consumption in that state of the world) of rational agents maximizing their expected utility.

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  • Elyès Jouini, 2001. "Arbitrage and Control Problems in Finance. Presentation," Post-Print halshs-00167152, HAL.
    • Handle: RePEc:hal:journl:halshs-00167152
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00167152
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