No‐Arbitrage in a Numéraire‐Independent Modeling Framework

36 Pages Posted: 28 May 2020

See all articles by Martin Herdegen

Martin Herdegen

University of Warwick - Department of Statistics

Date Written: April 2017

Abstract

The classic approach to modeling financial markets consists of four steps. First, one fixes a currency unit. Second, one describes in that unit the evolution of financial assets by a stochastic process. Third, one chooses in that unit a numéraire, usually the price process of a positive asset. Fourth, one divides the original price process by the numéraire and considers the class of admissible strategies for trading. This approach has one fundamental drawback: Almost all concepts, definitions, and results, including no‐arbitrage conditions like NA, NFLVR, and NUPBR depend by their very definition, at least formally, on initial choices of a currency unit and a numéraire. In this paper, we develop a new framework for modeling financial markets, which is not based on ex‐ante choices of a currency unit and a numéraire. In particular, we introduce a “numéraire‐independent” notion of no‐arbitrage and derive its dual characterization. This yields a numéraire‐independent version of the fundamental theorem of asset pricing (FTAP). We also explain how the classic approach and other recent approaches to modeling financial markets and studying no‐arbitrage can be embedded in our framework.

Keywords: numéraire‐independent modeling, no‐arbitrage, maximal strategies, fundamental theorem of asset pricing, nonnegative wealth

Suggested Citation

Herdegen, Martin, No‐Arbitrage in a Numéraire‐Independent Modeling Framework (April 2017). Mathematical Finance, Vol. 27, Issue 2, pp. 568-603, 2017, Available at SSRN: https://ssrn.com/abstract=3613143 or http://dx.doi.org/10.1111/mafi.12088

Martin Herdegen (Contact Author)

University of Warwick - Department of Statistics ( email )

Coventry CV4 7AL
United Kingdom

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