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Market Resolution and Valuation in Incomplete Markets

Published online by Cambridge University Press:  06 April 2009

Kose John
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Extract

The Arrow-Debreu approach to general equilibrium in an economy has been recognized as one of the most general and conceptually elegant frameworks for the study of financial problems under uncertainty [2], [9]. Equally well known is its elusiveness when it comes to ready application to practical problems (like capital budgeting) or empirical testing. (See [6], [15]–[18].) However, some recent research (see [1], [3], [6], [12]–[16], [18], and [19]) has made a serious attempt to put the state-preference theoretic model in an operational setting. Breeden and Litzenberger [6] have developed an interesting approach to derive constructively the prices of elementary Arrow-Debreu securities from the prices of call options on aggregate consumption. Banz and Miller [3] use a similar technique to value capital budgeting projects based on values for state-contingent claims computed from prices of call options written on the market portfolio. The “supershare” securities proposed by Hakansson [14]–[16] and related work by Garman [13], Ross [24], etc., have also served to give the so-called “state-contingent” approach a practical flavor.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 19 , Issue 1 , March 1984 , pp. 29 - 44
Copyright
Copyright © School of Business Administration, University of Washington 1984

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