Benchmarking and fair pricing applied to two market models
- Graduate School of Economics, Kyoto University
- Publication Type:
- Journal Article
- The Kyoto Economic Review, 2005, 74 (1), pp. 85 - 118
- Issue Date:
This paper considers a market containing both continuous and discrete noise. Modest assumptions ensure the existence of a growth optimal portfolio. Non-negative self-financing trading strategies, when benchmarked by this portfolio, are local martingales unde the real-world measure. This justifies the fair pricing approach, which expresses derivative prices in terms of real-world conditional expectations of benchmarked pay-offs. Two models for benchmarked primary security accounts are presentated, and fair pricing formulas for some common contingent claims are derived.
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