Local martingales, arbitrage, and viability

Mark Loewenstein and Gregory A. Willard ()
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Mark Loewenstein: John M. Olin School of Business, Washington University in Saint Louis, Campus Box 1133, One Brookings Drive, St. Louis, MO 63130-4899, USA
Gregory A. Willard: Sloan School of Management, Massachusetts Institute of Technology, 50 Memorial Drive, E52-431, Cambridge, MA 02142, USA

Economic Theory, 2000, vol. 16, issue 1, 135-161

Abstract: We revisit a standard model of security prices as Ito processes, and provide some new economic insights about the role of arbitrage and credit limits within such a model. We show that the standard assumptions of a positive state prices and existence of an equivalent martingale measure exclude prices that are viable models of competitive equilibrium and that are potentially useful for modeling actual financial markets. These models have been dismissed in the past as allowing arbitrage, but in fact an agent who prefers more to less and who has limited access to credit may have an optimum.

Keywords: Arbitrage; Viability; Wealth constraints; Continuous-time financial markets; Equivalent martingale measures. (search for similar items in EconPapers)
JEL-codes: D50 G12 G13 (search for similar items in EconPapers)
Date: 2000-04-14
Note: Received: June 9, 1999; revised version: October 4, 1999
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Citations: View citations in EconPapers (90)

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