Discussion and Applications

Abstract

Finance is an analytically challenging discipline. Often, simplifying assumptions or conditions, such as risk neutrality, a representative investor, arbitrage, or market efficiency, are imposed to allow formal models to be tractable. However, the overly simplifying assumptions run the risk of creating theories that create an analytic power that is out of proportion with the various assumptions, such as the premise of the efficient market hypothesis. Other models adopt assumptions of such strong generality that it becomes difficult to draw strong conclusions from them. This is the criticism that at times has been leveled against the APT.