A Disequilibrium Capital Asset Pricing Model
34 Pages Posted: 27 Apr 2018
Date Written: February 21, 2018
Economic models are almost exclusively static. The models describe equilibrium, but do not tell us the path taken to reach the equilibrium. By contrast, the model of asset pricing presented here is rarely in equilibrium; when equilibrium is reached, random forces perturb the price system away from equilibrium, which is followed by the gradual restoring force of rational traders who are attempting to earn profits from the market’s miss-pricing of capital assets. Trading takes place in continuous time. The rational traders are endowed with perfect knowledge of the current value of each security. However, they face uncertainty in their market positions because in order to exploit their superior knowledge they must trade with noise traders. The market is able to “clear” through the actions of a market maker. The opportunity set for risky assets is stochastic. General as well as specific solutions to the market dynamics problem are presented. It is shown that market prices are non-negative, but not necessarily bounded from above in finite time.
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