State prices implicit in valuation formulae for derivative securities: a martingale approach

Sven Rady

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Derivative assets analysis usually takes a model of the underlying price process as given and attempts to value derivative securities relative to that model. This paper studies the following "inverse" problem: given a valuation formula for a derivative asset, what can be inferred about the underlying asset price process? Assuming continuous sample paths, we show that a sufficiently regular pricing formula for some derivative asset completely determines the risk-neutral law of underlying price. In particular, such a valuation formula implies a unique set of state prices for payoffs contingent on the price path of the underlying security. As an illustration of our main result, we analyse certain pricing formulae for European options on zero-coupon bonds.

JEL-codes: G10 (search for similar items in EconPapers)
Pages: 16 pages
Date: 1994-10-01
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http://eprints.lse.ac.uk/119180/ Open access version. (application/pdf)

Related works:
Working Paper: State Prices Implicit in Valuation Formulae for Derivative Securities: A Martingale Approach (1994)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:119180

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