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Lecture

Asset Pricing: Valuation and Arbitrage

In course

FIN-609: Asset Pricing (2011 - 2024)

This course provides an overview of the theory of asset pricing and portfolio choice theory following historical developments in the field and putting emphasis on theoretical models that help our understanding of financial decision making and financial mar ...

Description

This lecture covers the connection between absence of arbitrage and the solution to an individual's consumption-portfolio problem, the extension of payoff functional to the entire contingent claim space, the fundamental theorem of asset pricing, and the concept of state prices, risk-neutral measure, stochastic discount factor, and pricing kernel.

Instructor

Semyon Malamud

Official source

Ontological neighbourhood

Economics

Microeconomics: Financial economics

Related concepts (32)

Fundamental theorem of asset 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.

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 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.

Asset pricing

In financial economics, asset pricing refers to a formal treatment and development of two main 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 asset pricing or rational asset pricing, the latter corresponding to risk neutral pricing.

Capital asset pricing model

In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.

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 is the practice of taking advantage of a state of imbalance between two (or possibly more) markets. Where this mismatch can be exploited (i.

Related lectures (58)

Equilibrium State Prices Determination

Explains the determination of equilibrium state prices in asset pricing through consumption market clearing and budget constraints.

Asset Pricing: Risk-Neutral Measure and State Prices

Covers risk-neutral measure, state prices, utility functions, and risk aversion in asset pricing.

Asset Pricing: Theory and Applications

Explores asset pricing theory, market efficiency, risk-return relationship, and the efficient frontier.

Market Structure: Portfolio, Arbitrage, and Consumption

Explores market structure, portfolio holdings, arbitrage, state prices, and optimal consumption-portfolio choices.

Dynamic Arbitrage: Asset Pricing