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The Theory of Good-Deal Pricing in Financial Markets

  • Aleš Černý
  • Stewart Hodges
Part of the Springer Finance book series (FINANCE)

Abstract

The term ‘no-good-deal pricing’ in this paper encompasses pricing techniques base on the absence of attractive investment opportunities — good deals — in equilibrium. We borrowed the term from [8] who pioneered the calculation of price bands conditional on the absence of high Sharpe Ratios. Alternative methodologies for calculating tighter-than-no-arbitrage price bounds have been suggested by [4], [6], [12]. The theory presented here shows that any of these techniques can be seen as a generalization of no-arbitrage pricing. The common structure is provided by the Extension and Pricing Theorems, already well known from no-arbitrage pricing, see [15]. We derive these theorems in no-good-deal framework and establish general properties of no-good-deal prices. These abstract results are then applied to no-goos-deal bounds determined by von Neumann-Morgenstern preferences in a finite state model1. One important result is that no-good-deal bouns generated by an unbounded utility function are always strictly tighter than the no-arbitrage bounds. The same is not true for bounded utility functions. For smooth utility functions we show that one will obtain the no-arbitrage and the representative agent equilibrium as the two opposite ends of a spectrum of no-good-deal equilibrium restrictions indexed by the maximum attainable certainty equivalent gains.

Keywords

Good Deal Sharpe Ratio Complete Market Basis Asset Positive Claim 
These keywords were added by machine and not by the authors. This process is experimental and the keywords may be updated as the learning algorithm improves.

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Copyright information

© Springer-Verlag Berlin Heidelberg 2002

Authors and Affiliations

  • Aleš Černý
    • 1
  • Stewart Hodges
    • 1
  1. 1.Imperial College Management School Financial Options Research CentreUniversity of WarwickUK

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