NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Beyond Arbitrage: "Good-Deal" Asset Price Bounds in Incomplete Markets

John H. Cochrane, Jesus Saa-Requejo

NBER Working Paper No. 5489
Issued in March 1996
NBER Program(s):   AP

It is often useful to price assets and other random payoffs by reference to other observed prices rather than construct full-fledged economic asset pricing models. This approach breaks down if one cannot find a perfect replicating portfolio. We impose weak economic restrictions to derive usefully tight bounds on asset prices in this situation. The bounds basically rule out high Sharpe ratios - `good deals' - as well as arbitrage opportunities. We present the method of calculation, we extend it to a multiperiod context by finding a recursive solution, and we apply it to option pricing examples including the Black-Scholes setup with infrequent trading, and a model with stochastic stock volatility and a varying riskfree rate.

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Document Object Identifier (DOI): 10.3386/w5489

Published: Journal of Political Economy (February 2000 Revision of W5489, March 1996) citation courtesy of

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