 The risk neutral valuation paradoxA. Fiori Maccioni Working Paper CRENoS from Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia Abstract: This paper highlights the role of risk neutral investors in generating endogenous bubbles in derivatives markets. We propose the following theorem. A market for derivatives, which has all the features of a perfect market except completeness and has some risk neutral investors, may exhibit almost surely extreme price movements which represent a violation to the Gaussian random walk hypothesis. This can be viewed as a paradox because it contradicts wide-held conjectures about prices in informationally efficient markets with rational investors. The theorem implies that prices are not always good approximations of the fundamental values of derivatives, and that extreme price movements like price peaks or crashes may have endogenous origin and happen with a higher-than-normal frequency. In the paper, we demonstrate the theorem and we propose an application that solves the Grossman- Stiglitz paradox on the value of information. Keywords: risk neutral; martingale; derivatives; efficient market; fundamental theorem; bubble (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:cns:cnscwp:201112 Access Statistics for this paper More papers in Working Paper CRENoS from Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia Contact information at EDIRC. |
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