Arbitrage, bubbles and valuation
The standard present value rule of asset pricing may fail in financial markets when infinitely many assets can be traded. The author provides an example of asset payoffs and prices such that prices are arbitrage-free and could be equilibrium prices in frictionless markets. Using valuation theory methods, the author shows that asset prices can be meaningfully decomposed into a fundamental value and a pricing bubble. The fundamental value obeys the present value rule. Copyright 1997 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.
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