Arbitrage Pricing: Finite-State Models
Asset Pricing Models
Published Online: 15 DEC 2012
Copyright © 2013 by Frank J. Fabozzi. All rights reserved.
Encyclopedia of Financial Models
How to Cite
Focardi, S. M. and Fabozzi, F. J. 2012. Arbitrage Pricing: Finite-State Models. Encyclopedia of Financial Models. .
- 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;
- law of one price;
- state prices;
- risk-neutral probabilities;
- complete markets;
- state-price deflator;
- propagation of information;
- equivalent martingale measures;
- equivalent probability measures