Diversity and Arbitrage in a Regulatory Breakup Model

Annals of Finance 7.3 (2011): 349-374

21 Pages Posted: 28 Oct 2013

See all articles by Winslow Strong

Winslow Strong

ETH Zurich, Department of Mathematics

Jean-Pierre Fouque

University of California, Santa Barbara (UCSB) - Statistics & Applied Probablity

Date Written: August 21, 2010

Abstract

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

Strong, Winslow and Fouque, Jean-Pierre, Diversity and Arbitrage in a Regulatory Breakup Model (August 21, 2010). Annals of Finance 7.3 (2011): 349-374, Available at SSRN: https://ssrn.com/abstract=1732824

Winslow Strong (Contact Author)

ETH Zurich, Department of Mathematics ( email )

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ZUE F7
Zürich, 8092
Switzerland
41786995026 (Phone)

HOME PAGE: http://www.winslowstrong.com

Jean-Pierre Fouque

University of California, Santa Barbara (UCSB) - Statistics & Applied Probablity ( email )

United States

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