Diversity and Arbitrage in a Regulatory Breakup Model
Annals of Finance 7.3 (2011): 349-374
21 Pages Posted: 28 Oct 2013
Date Written: August 21, 2010
In 1999 Robert Fernholz observed an inconsistency between the normative assumption of existence of an equivalent martingale measure (EMM) and the empirical reality of diversity in equity markets. We explore a method of imposing diversity on market models by a type of antitrust regulation that is compatible with EMMs. The regulatory procedure breaks up companies that become too large, while holding the total number of companies constant by imposing a simultaneous merge of other companies. The regulatory events are assumed to have no impact on portfolio values. As an example, regulation is imposed on a market model in which diversity is maintained via a log-pole in the drift of the largest company. The result is the removal of arbitrage opportunities from this market while maintaining the market's diversity.
Keywords: Diversity, Arbitrage, Relative arbitrage, Equivalent martingale measure, Antitrust, Regulation
JEL Classification: G11
Suggested Citation: Suggested Citation