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Fundamental theorem of asset pricing with acceptable risk in markets with frictions

Author

Listed:
  • Maria Arduca

    (LUISS University)

  • Cosimo Munari

    (University of Zurich)

Abstract

We study the range of prices at which a rational agent should contemplate transacting a financial contract outside a given market. Trading is subject to nonproportional transaction costs and portfolio constraints, and full replication by way of market instruments is not always possible. Rationality is defined in terms of consistency with market prices and acceptable risk thresholds. We obtain a direct and a dual description of market-consistent prices with acceptable risk. The dual characterisation requires an appropriate extension of the classical fundamental theorem of asset pricing where the role of arbitrage opportunities is played by good deals, i.e., costless investment opportunities with acceptable risk–reward tradeoff. In particular, we highlight the importance of scalable good deals, i.e., investment opportunities that are good deals regardless of their volume.

Suggested Citation

  • Maria Arduca & Cosimo Munari, 2023. "Fundamental theorem of asset pricing with acceptable risk in markets with frictions," Finance and Stochastics, Springer, vol. 27(3), pages 831-862, July.
    • Handle: RePEc:spr:finsto:v:27:y:2023:i:3:d:10.1007_s00780-023-00509-x
    DOI: 10.1007/s00780-023-00509-x
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    1. Martin Herdegen & Cosimo Munari, 2023. "An elementary proof of the dual representation of Expected Shortfall," Papers 2306.14506, arXiv.org.
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    More about this item

    Keywords

    Arbitrage pricing; Good deal pricing; Transaction costs; Portfolio constraints; Risk measures;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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