Arbitrage Pricing: Finite-State Models

Asset Pricing Models

  1. Sergio M. Focardi PhD1,
  2. Frank J. Fabozzi PhD, CFA, CPA2

Published Online: 15 DEC 2012

DOI: 10.1002/9781118182635.efm0009

Encyclopedia of Financial Models

Encyclopedia of Financial Models

How to Cite

Focardi, S. M. and Fabozzi, F. J. 2012. Arbitrage Pricing: Finite-State Models. Encyclopedia of Financial Models. .

Author Information

  1. 1

    Partner, The Intertek Group

  2. 2

    Professor of Finance, EDHEC Business School

Publication History

  1. Published Online: 15 DEC 2012


Arbitrage in its most basic form involves the simultaneous buying and selling of an asset at two different prices in two different markets. In real-world financial markets, arbitrage opportunities rarely, if ever, exist. Less obvious arbitrage opportunities exist in situations where a package of assets can be assembled that have a payoff (return) that is identical to an asset that is priced differently. A market is said to be a complete market if an arbitrary payoff can be replicated by a portfolio. The most fundamental principle in asset pricing theory is the absence of arbitrage opportunities.


  • absence of arbitrage;
  • finite-state;
  • arbitrage;
  • law of one price;
  • state prices;
  • risk-neutral probabilities;
  • complete markets;
  • state-price deflator;
  • propagation of information;
  • equivalent martingale measures;
  • equivalent probability measures