Abandoning the Law of One Price: Economic Foundations and Mathematical Structure of Two Price Economies

Tue, 01/07/2014 - 5:30pm

Dilip Madan, Robert H. Smith School of Business, University of Maryland


Westpac Conference Centre, Plaza Level, 60 Martin Place, Sydney


Two price economies arise when market clearing fails leaving the market exposed to residual risk. Financial market valuation operators in such economies, in the absence of arbitrage, turn out to be nonlinear martingales. The new nonlinear valuation methodology leads, in particular, to new approaches for designing portfolios, constructing hedges, investing in options, de…fining risk sensitive capital, while simultaneously providing new insights into the management of corporate entities and for the …financial accounting of economic activity. The talk will brie‡fly introduce the structure of nonlinear martingales and their connection to two price economies and will then move on to highlight the various applications that have already been made.

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