Market Clearing and Derivative Pricing.

Abstract

We develop a method of assigning unique prices to derivative securities, including options, in the continuous-time finance models developed in Raimondo [45] and Anderson and Raimondo [6]. In contrast with the martingale method of valuing options, which cannot distinguish among infinitely many possible option pricing processes for a given underlying securities price process when markets are dynamically incomplete, our option prices are uniquely determined in equilibrium as a function of the underlying economic data and the underlying securities price process; in the single-agent model, this function is given in closed form.