Fragility of Local Martingale Diffusion Models of Arbitrage and Bubbles

17 Pages Posted: 1 Jun 2011 Last revised: 3 Feb 2014

See all articles by Paolo Guasoni

Paolo Guasoni

Dublin City University - School of Mathematical Sciences; Boston University - Department of Mathematics and Statistics

Miklos Rasonyi

University of Edinburgh - School of Mathematics

Date Written: January 29, 2014

Abstract

For any positive diffusion with minimal regularity, there exists a semimartingale, with uniformly close paths, which is a martingale under an equivalent probability. As a result, in models of asset prices based on such diffusions, arbitrage and bubbles alike disappear under proportional transaction costs, or under small model misspecifications. Thus, local martingale models of arbitrage and bubbles are not robust to small trading and monitoring frictions.

Keywords: Arbitrage, Bubbles, Transaction Costs, Local Martingales

JEL Classification: G12

Suggested Citation

Guasoni, Paolo and Rasonyi, Miklos, Fragility of Local Martingale Diffusion Models of Arbitrage and Bubbles (January 29, 2014). Boston U. School of Management Research Paper No. 2011-12, Available at SSRN: https://ssrn.com/abstract=1856223 or http://dx.doi.org/10.2139/ssrn.1856223

Paolo Guasoni (Contact Author)

Dublin City University - School of Mathematical Sciences ( email )

Dublin
Ireland

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

Boston University - Department of Mathematics and Statistics ( email )

Boston, MA 02215
United States

Miklos Rasonyi

University of Edinburgh - School of Mathematics ( email )

United Kingdom

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