A non-arbitrage liquidity model with observable parameters for derivatives

We develop a parameterised model for liquidity effects arising from the trading in an asset. Liquidity is defined via a combination of a trader's individual transaction cost and a price slippage impact, which is felt by all market participants. The chosen definition allows liquidity to be observable in a centralised order-book of an asset as is usually provided in most non-specialist exchanges. The discrete-time version of the model is based on the CRR binomial tree and in the appropriate continuous-time limits we derive various nonlinear partial differential equations. Both versions can be directly applied to the pricing and hedging of options; the nonlinear nature of liquidity leads to natural bid-ask spreads that are based on the liquidity of the market for the underlying and the existence of (super-)replication strategies. We test and calibrate our model set-up empirically with high-frequency data of German blue chips and discuss further extensions to the model, including stochastic liquidity

Ambiguity in asset pricing and portfolio choice: a review of the literature

A growing body of empirical evidence suggests that investors’ behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the empirical failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free rate puzzles, and the occurrence of trading break-downs.Capital assets pricing model ; Investments

Bond markets where prices are driven by a general marked point process

We investigate the term structure for the case when interest rates are allowed to be driven by a general marked point process as well as by a Wiener process. Developing a theory which allows for measure-valued trading portfolios we study existence and uniqueness of a martingale measure, as well as completeness of the bond market. We also give sufficient conditions for the existence of an affine term structure. Developing the appropriate forward measures we give formulas for interest rate derivatives.Term structure of interest rates; arbitrage; bond markets; interest rates; martingales; jump processes; completeness; affine term structure

A fundamental theorem of asset pricing for continuous time large financial markets in a two filtration setting

We present a version of the fundamental theorem of asset pricing (FTAP) for continuous time large financial markets with two filtrations in an $L^p$-setting for $1 \leq p < \infty$. This extends the results of Yuri Kabanov and Christophe Stricker \cite{KS:06} to continuous time and to a large financial market setting, however, still preserving the simplicity of the discrete time setting. On the other hand it generalizes Stricker's $L^p$-version of FTAP \cite{S:90} towards a setting with two filtrations. We do neither assume that price processes are semi-martigales, (and it does not follow due to trading with respect to the \emph{smaller} filtration) nor that price processes have any path properties, neither any other particular property of the two filtrations in question, nor admissibility of portfolio wealth processes, but we rather go for a completely general (and realistic) result, where trading strategies are just predictable with respect to a smaller filtration than the one generated by the price processes. Applications range from modeling trading with delayed information, trading on different time grids, dealing with inaccurate price information, and randomization approaches to uncertainty