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Principles for modelling financial markets

Part of: Stochastic processes Stochastic analysis

Published online by Cambridge University Press:  14 July 2016

Eckhard Platen  and
Rolando Rebolledo
Eckhard Platen*
Affiliation:
Australian National University
Rolando Rebolledo*
Affiliation:
Universidad Católica de Chile
*
∗ Postal address: Australian National University, SMS, Centre for Financial Mathematics, Canberra, ACT, 0200, Australia.
∗∗ Postal address: Universidad Católica de Chile, Facultad de Matemática, Casilla 306, Santiago 22, Chile.
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Abstract

The paper introduces an approach focused towards the modelling of dynamics of financial markets. It is based on the three principles of market clearing, exclusion of instantaneous arbitrage and minimization of increase of arbitrage information. The last principle is equivalent to the minimization of the difference between the risk neutral and the real world probability measures. The application of these principles allows us to identify various market parameters, e.g. the risk-free rate of return. The approach is demonstrated on a simple financial market model, for which the dynamics of a virtual risk-free rate of return can be explicitly computed.

Keywords

STOCHASTIC DIFFERENTIAL EQUATIONSMARTINGALESARBITRAGE INFORMATION

MSC classification

Primary: 60H10: Stochastic ordinary differential equations
Secondary: 60G35: Signal detection and filtering

Information

Type
Research Papers
Information
Journal of Applied Probability , Volume 33 , Issue 3 , September 1996 , pp. 601 - 613
Copyright
Copyright © Applied Probability Trust 1996 

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