Can You Hear the Shape of a Market? Geometric Arbitrage and Spectral Theory

44 Pages Posted: 16 Aug 2015 Last revised: 30 Jun 2019

Date Written: June 11, 2019

Abstract

Geometric Arbitrage Theory reformulates a generic asset model possibly allowing for arbitrage by packaging all assets and their forwards dynamics into a stochastic principal fibre bundle, with a connection whose parallel transport encodes discounting and portfolio rebalancing, and whose curvature measures, in this geometric language, the ''instantaneous arbitrage capability'' generated by the market itself. The cashflow bundle is the vector bundle associated to this stochastic principal fibre bundle for the natural choice of the vector space fibre. The cashflow bundle carries a stochastic covariant differentiation induced by the connection on the principal fibre bundle. The link between arbitrage theory and spectral theory of the connection Laplacian on the vector bundle is given by the zero eigenspace resulting in a parametrization of all risk neutral measures equivalent to the statistical one. This indicates that a market satisfies the (NFLVR) condition if and only if $0$ is in the discrete spectrum of the connection Laplacian on the cash flow bundle or of the Dirac Laplacian of the twisted cash flow bundle with the exterior algebra bundle. We apply this result by extending Jarrow-Protter-Shimbo theory of asset bubbles for complete arbitrage free markets to markets not satisfying the (NFLVR). Moreover, by means of the Atiyah-Singer index theorem, we prove that the Euler characteristic of the asset nominal space is a topological obstruction to the the (NFLVR) condition, and, by means of the Bochner-Weitzenb\öck formula, the non vanishing of the homology group of the cash flow bundle is revealed to be a topological obstruction to (NFLVR), too. Asset bubbles are defined, classified and decomposed for markets allowing arbitrage.

Keywords: Arbitrage, Spectral Theory, Stochastic Differential Geometry

JEL Classification: C60

Suggested Citation

Farinelli, Simone and Takada, Hideyuki, Can You Hear the Shape of a Market? Geometric Arbitrage and Spectral Theory (June 11, 2019). Available at SSRN: https://ssrn.com/abstract=2644756 or http://dx.doi.org/10.2139/ssrn.2644756

Simone Farinelli (Contact Author)

Core Dynamics GmbH ( email )

Scheuzerstrasse 43
Zurich, 8006
Switzerland

Hideyuki Takada

Toho University ( email )

Room 4421
Miyama 2-2-1
Funabashi, Chiba 274-8510
Japan
(+81)-47-472-1856 (Phone)

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