Securities Markets, Diffusion State Processes, and Arbitrage-Free Shadow Prices

John Heaney and Geoffrey Poitras

Journal of Financial and Quantitative Analysis, 1994, vol. 29, issue 2, 223-239

Abstract: This paper develops the parametric restrictions imposed on diffusion state processes by the requirement of arbitrage-free asset pricing. Using the equivalent martingale measure as a starting point, the diffusion property is exploited to specify the shadow pricing function, which takes conditional state variable probabilities under the reference measure into arbitrage-free contingent claim prices. The main results of the paper provide differential equations associated with the shadow price function that are used to identify restrictions on the parameters of assumed diffusion processes. The paper concludes with an application to the CIR model where the state variable, the instantaneous interest rate, is assumed to follow a square root process. Calculations are also provided for the parametric restrictions imposed on the Brownian bridge and OU state variable processes.

Date: 1994
References: Add references at CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://www.cambridge.org/core/product/identifier/ ... type/journal_article link to article abstract page (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cup:jfinqa:v:29:y:1994:i:02:p:223-239_00

Access Statistics for this article

More articles in Journal of Financial and Quantitative Analysis from Cambridge University Press Cambridge University Press, UPH, Shaftesbury Road, Cambridge CB2 8BS UK.
Bibliographic data for series maintained by Kirk Stebbing ().