First steps towards an equilibrium theory for Lévy financial markets

Frederik Herzberg

Annals of Finance, 2013, vol. 9, issue 3, 543-572

Abstract: For a continuous-time financial market with a single agent, we establish equilibrium pricing formulae under the assumption that the dividends follow an exponential Lévy process. The agent is allowed to consume a lump at the terminal date; before that, only flow consumption is allowed. The agent’s utility function is assumed to be additive, defined via strictly increasing, strictly concave smooth felicity functions which are bounded below (thus, many CRRA and CARA utility functions are included). For technical reasons we require for our equilibrium existence result that only pathwise continuous trading strategies are permitted in the demand set. The resulting equilibrium asset price processes depend on the agent’s risk aversion (through the felicity functions). Even in our simple, straightforward economy, the equilibrium asset price processes will essentially only be (stochastic) exponential Lévy processes when they are already geometric Brownian motions. Our equilibrium asset pricing formulae can also be modified to obtain explicit equilibrium derivative pricing formulae. Copyright Springer-Verlag 2013

Keywords: Financial equilibrium; Continuous-time financial markets; Derivative pricing; Lévy process; Nonstandard analysis; Representative-agent models; D53; G13; D52 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s10436-012-0202-5

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