Digital assets, bubbles, and derivative prices

Robert A. Jarrow ()
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Robert A. Jarrow: Cornell University

Review of Derivatives Research, 2025, vol. 28, issue 3, No 4, 16 pages

Abstract: Abstract In a standard no-arbitrage continuous-time model, this paper characterizes a digital asset’s price process as being decomposed into four components: its fundamental value and three different types of bubbles, labeled type 1, 2 and 3. Type 1 bubbles are permanent, type 2 are long-horizon, and type 3 are short-horizon. Only type 3 (short-horizon) bubbles are not martingales under an equivalent local martingale measure. This decomposition implies the standard derivative pricing methodology does not apply to digital assets whose market prices reflect type 3 (short-horizon) bubbles. Modifications to the existing derivative pricing theory needed for digital assets with price bubbles are explored herein.

Keywords: Digital assets; Stablecoins; Price bubbles; Derivative pricing; Martingale measures; No-arbitrage (search for similar items in EconPapers)
JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 2025
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DOI: 10.1007/s11147-025-09220-9

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