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Fundamental Theorem Of Arbitrage-free Pricing
The fundamental theorems of asset pricing (also: of arbitrage, of finance), in both financial economics and mathematical finance, provide necessary and sufficient conditions for a market to be arbitrage-free, and for a market to be complete. An arbitrage opportunity is a way of making money with no initial investment without any possibility of loss. Though arbitrage opportunities do exist briefly in real life, it has been said that any sensible market model must avoid this type of profit.Pascucci, Andrea (2011) ''PDE and Martingale Methods in Option Pricing''. Berlin: Springer-Verlag The first theorem is important in that it ensures a fundamental property of market models. Completeness is a common property of market models (for instance the Black–Scholes model). A complete market is one in which every contingent claim can be replicated. Though this property is common in models, it is not always considered desirable or realistic. Discrete markets In a discrete (i.e. finite state ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Financial Economics
Financial economics is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on ''both sides'' of a trade".William F. Sharpe"Financial Economics", in Its concern is thus the interrelation of financial variables, such as share prices, interest rates and exchange rates, as opposed to those concerning the real economy. It has two main areas of focus:Merton H. Miller, (1999). The History of Finance: An Eyewitness Account, ''Journal of Portfolio Management''. Summer 1999. asset pricing and corporate finance; the first being the perspective of providers of Financial capital, capital, i.e. investors, and the second of users of capital. It thus provides the theoretical underpinning for much of finance. The subject is concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment".See Fama and Miller (1972), ''The Theory of Finance'', ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Financial Economics
Financial economics is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on ''both sides'' of a trade".William F. Sharpe"Financial Economics", in Its concern is thus the interrelation of financial variables, such as share prices, interest rates and exchange rates, as opposed to those concerning the real economy. It has two main areas of focus:Merton H. Miller, (1999). The History of Finance: An Eyewitness Account, ''Journal of Portfolio Management''. Summer 1999. asset pricing and corporate finance; the first being the perspective of providers of Financial capital, capital, i.e. investors, and the second of users of capital. It thus provides the theoretical underpinning for much of finance. The subject is concerned with "the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment".See Fama and Miller (1972), ''The Theory of Finance'', ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Rational Pricing
Rational pricing is the assumption in financial economics that asset prices – and hence asset pricing models – will reflect the arbitrage-free price of the asset as any deviation from this price will be "arbitraged away". This assumption is useful in pricing fixed income securities, particularly bonds, and is fundamental to the pricing of derivative instruments. Arbitrage mechanics Arbitrage is the practice of taking advantage of a state of imbalance between two (or possibly more) markets. Where this mismatch can be exploited (i.e. after transaction costs, storage costs, transport costs, dividends etc.) the arbitrageur can "lock in" a risk-free profit by purchasing and selling simultaneously in both markets. In general, arbitrage ensures that "the law of one price" will hold; arbitrage also equalises the prices of assets with identical cash flows, and sets the price of assets with known future cash flows. The law of one price The same asset must trade at the same ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Asset Pricing
In financial economics, asset pricing refers to a formal treatment and development of two interrelated Price, pricing principles, outlined below, together with the resultant models. There have been many models developed for different situations, but correspondingly, these stem from either General equilibrium theory, general equilibrium asset pricing or Rational pricing, rational asset pricing, the latter corresponding to risk neutral pricing. Investment theory, which is near synonymous, encompasses the body of knowledge used to support the decision-making process of choosing investments, and the asset pricing models are then applied in determining the Required rate of return, asset-specific required rate of return on the investment in question, and for hedging. General equilibrium asset pricing Under general equilibrium theory prices are determined through Market price, market pricing by supply and demand. See, e.g., Tim Bollerslev (2019)"Risk and Return in Equilibrium: The C ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Arbitrage Pricing Theory
In finance, arbitrage pricing theory (APT) is a multi-factor model for asset pricing which relates various macro-economic (systematic) risk variables to the pricing of financial assets. Proposed by economist Stephen Ross (economist), Stephen Ross in 1976, it is widely believed to be an improved alternative to its predecessor, the capital asset pricing model (CAPM). APT is founded upon the law of one price, which suggests that within an equilibrium market, rational investors will implement arbitrage such that the equilibrium price is eventually realised. As such, APT argues that when opportunities for arbitrage are exhausted in a given period, then the expected return of an asset is a linear function of various factors or theoretical market indices, where sensitivities of each factor is represented by a factor-specific beta coefficient or factor loading. Consequently, it provides traders with an indication of ‘true’ asset value and enables exploitation of market discrepancies via ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
No Free Lunch With Vanishing Risk
No free lunch with vanishing risk (NFLVR) is a concept used in mathematical finance as a strengthening of the no-arbitrage condition. In continuous time finance the existence of an equivalent martingale measure (EMM) is no more equivalent to the no-arbitrage-condition (unlike in discrete time finance), but is instead equivalent to the NFLVR-condition. This is known as the first fundamental theorem of asset pricing. Informally speaking, a market allows for a ''free lunch with vanishing risk'' if there are admissible strategies, which can be chosen arbitrarily close to an arbitrage strategy, i.e., these strategies start with no wealth, end up with positive wealth with probability greater than zero (free lunch) and the probability of ending up with negative wealth can be chosen arbitrarily small (vanishing risk). Mathematical definition For a semimartingale S, let * K = \ where a strategy is called admissible if it is self-financing and its value process V_t=\int_0^t H_u \cdot \ ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Semimartingale
In probability theory, a real-valued stochastic process ''X'' is called a semimartingale if it can be decomposed as the sum of a local martingale and a càdlàg adapted finite-variation process. Semimartingales are "good integrators", forming the largest class of processes with respect to which the Itô integral and the Stratonovich integral can be defined. The class of semimartingales is quite large (including, for example, all continuously differentiable processes, Brownian motion and Poisson processes). Submartingales and supermartingales together represent a subset of the semimartingales. Definition A real-valued process ''X'' defined on the filtered probability space (Ω,''F'',(''F''''t'')''t'' ≥ 0,P) is called a semimartingale if it can be decomposed as :X_t = M_t + A_t where ''M'' is a local martingale and ''A'' is a càdlàg adapted process of locally bounded variation. This means that for almost all \omega \in \Omega and all compact intervals ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Sigma-martingale
In mathematics and information theory of probability, a sigma-martingale is a semimartingale with an integral representation. Sigma-martingales were introduced by C.S. Chou and M. Emery in 1977 and 1978. In financial mathematics, sigma-martingales appear in the fundamental theorem of asset pricing as an equivalent condition to no free lunch with vanishing risk (a no-arbitrage condition). Mathematical definition An \mathbb^d-valued stochastic process X = (X_t)_^T is a ''sigma-martingale'' if it is a semimartingale In probability theory, a real-valued stochastic process ''X'' is called a semimartingale if it can be decomposed as the sum of a local martingale and a càdlàg adapted finite-variation process. Semimartingales are "good integrators", forming the ... and there exists an \mathbb^d-valued martingale ''M'' and an ''M''- integrable predictable process \phi with values in \mathbb_+ such that :X = \phi \cdot M. References Martingale theory {{probability-st ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Brownian Motion
Brownian motion is the random motion of particles suspended in a medium (a liquid or a gas). The traditional mathematical formulation of Brownian motion is that of the Wiener process, which is often called Brownian motion, even in mathematical sources. This motion pattern typically consists of Randomness, random fluctuations in a particle's position inside a fluid sub-domain, followed by a relocation to another sub-domain. Each relocation is followed by more fluctuations within the new closed volume. This pattern describes a fluid at thermal equilibrium, defined by a given temperature. Within such a fluid, there exists no preferential direction of flow (as in transport phenomena). More specifically, the fluid's overall Linear momentum, linear and Angular momentum, angular momenta remain null over time. The Kinetic energy, kinetic energies of the molecular Brownian motions, together with those of molecular rotations and vibrations, sum up to the caloric component of a fluid's in ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Risk-free Bond
A risk-free bond is a theoretical bond that repays interest and principal with absolute certainty. The rate of return would be the risk-free interest rate. It is primary security, which pays off 1 unit no matter state of economy is realized at time t+1 . So its payoff is the same regardless of what state occurs. Thus, an investor experiences no risk by investing in such an asset. In practice, government bonds of financially stable countries are treated as risk-free bonds, as governments can raise taxes or indeed print money to repay their domestic currency debt. For instance, United States Treasury notes and United States Treasury bonds are often assumed to be risk-free bonds. Even though investors in United States Treasury securities do in fact face a small amount of credit risk, this risk is often considered to be negligible. An example of this credit risk was shown by Russia, which defaulted on its domestic debt during the 1998 Russian financial crisis. Modelling the pric ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
Mathematical Finance
Mathematical finance, also known as quantitative finance and financial mathematics, is a field of applied mathematics, concerned with mathematical modeling in the financial field. In general, there exist two separate branches of finance that require advanced quantitative techniques: derivatives pricing on the one hand, and risk and portfolio management on the other. Mathematical finance overlaps heavily with the fields of computational finance and financial engineering. The latter focuses on applications and modeling, often with the help of stochastic asset models, while the former focuses, in addition to analysis, on building tools of implementation for the models. Also related is quantitative investing, which relies on statistical and numerical models (and lately machine learning) as opposed to traditional fundamental analysis when managing portfolios. French mathematician Louis Bachelier's doctoral thesis, defended in 1900, is considered the first scholarly work on ... [...More Info...] [...Related Items...] OR: [Wikipedia] [Google] [Baidu] |
