Lecture

Arbitrage in Multiperiod Models

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In course

FIN-404: Derivatives

This course provides a detailed presentation of the standard models for the valuation and hedging of derivatives products such as European options, American options, forward contracts, futures contract and exotic options. ...

Description

This lecture covers the concept of arbitrage in multiperiod models, focusing on dynamic trading, absence of arbitrage, and the use of filtrations to represent information availability. It discusses trading strategies, discounted prices, value processes, martingales, and the Fundamental Theorem of Asset Pricing. Examples illustrate the application of these concepts in financial modeling.

Instructor

Julien Hugonnier

Expertise Asset pricing theory, incomplete markets and financial frictions, general equilibrium theory, decision making under uncertainty Teaching & PhD PhD Students Luca Pagliuca, Darius Nik Nejad Past EPFL PhD Students Rodolfo Javier Prieto Katunaric, Michael Hasler, Giuliano Antonio Curatola, Julien Cujean, Thomas Antonius Geelen, Nicolas Gauderon, Benoit Vincent Sylvain Cornet Past EPFL PhD Students as codirector Rémy Praz, Cagil Kocyigit, Alexis Marchal Courses Derivatives FIN-404 Thi

Official source

Ontological neighbourhood

Economics

Microeconomics: Financial economics

Related concepts (31)

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.

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.

Efficient-market hypothesis

The efficient-market hypothesis (EMH) is a hypothesis in financial economics that states that asset prices reflect all available information. A direct implication is that it is impossible to "beat the market" consistently on a risk-adjusted basis since market prices should only react to new information. Because the EMH is formulated in terms of risk adjustment, it only makes testable predictions when coupled with a particular model of risk.

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.

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