Lecture#6 - Ec 136 Financial Economics Lecture 6 September 17 Outline for today 1 Complete markets 2 Dynamic trading

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Unformatted text preview: Ec 136, Financial Economics Lecture 6 September 17 Outline for today 1. Complete markets. 2. Dynamic trading. www.econ.berkeley.edu/~szeidl/ec136/ec136index.htm Readings for this week: BKM Chapter 20.1, 20.2, 20.4, start reading Chapter 14.1-14.4. Problem set 2 : due September 17, Thurs, in class. 1. Complete markets & Remember, a market is complete if Arrow-Debreu securities exist for all states of the world... AD1 AD2 AD3 Asset 1 Asset 2 State 1 1 3 X 1 State 2 1 2 X 2 State 3 1 1 X 3 Price S 1 S 2 S 3 & In which case we can price all assets using the Arrow-Debreu prices P X = X 1 S 1 + X 2 S 2 + X 3 S 3 : Finding AD securities Asset 1 Asset 2 State 1 3 5 State 2 1 5 Price 2 4 & Let’s create AD1 by purchasing Q 1 of asset 1 and Q 2 of asset 2. 3 Q 1 + 5 Q 2 = 1 Q 1 + 5 Q 2 = 0 : & Solving yields Q 1 = 0 : 5 and Q 2 = ¡ : 1. State price is S 1 = 0 : 5 ¢ 2 ¡ : 1 ¢ 4 = 0 : 6. { Similarly S 2 = 0 : 2. & Can now use AD securities to price any asset. & Basic intuition: can unpackage and repackage payo&s of a security using more basic securities. 2. Dynamic trading & Are markets complete in practice, given that...
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This note was uploaded on 09/02/2010 for the course ECON 136 taught by Professor Szeidl during the Fall '08 term at University of California, Berkeley.

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Lecture#6 - Ec 136 Financial Economics Lecture 6 September 17 Outline for today 1 Complete markets 2 Dynamic trading

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