Principles of Financial Economics by Stephen F. LeRoy

By Stephen F. LeRoy

This publication introduces graduate scholars in economics to the subfield of economic economics. It stresses the hyperlink among monetary economics and equilibrium concept, devoting much less recognition to merely monetary subject matters equivalent to valuation of derivatives. given that scholars usually locate this hyperlink difficult to understand, the remedy goals to make the relationship specific and transparent in every one degree of the exposition. Emphasis is put on designated examine of two-date types, simply because just about all of the most important principles in monetary economics may be constructed within the two-date environment. The research is meant to be similar in rigor to the easiest paintings in microeconomics; while, the authors offer sufficient dialogue and examples to make the guidelines comfortably comprehensible.

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6 Diagrammatic Representation In Chapter 3 we presented a diagrammatic method of determining the set of security prices that exclude arbitrage when there are no short sales restrictions. In the presence of short sales restrictions we are interested in determining the set of security prices that exclude unlimited arbitrage. The diagrammatic treatment is readily extended to this case. Suppose that there are two securities, and that short selling of security 2 is restricted. 3, then there is no limited or unlimited arbitrage portfolio.

5. UNIQUENESS OF THE VALUATION FUNCTIONAL 47 Notes The term “Fundamental Theorem of Finance” is due to Dybvig and Ross [3]. The first statement and proof of the Fundamental Theorem of Finance appears in [4] and [5]. See also Beja [1]. The derivation of the valuation functional by extending the payoff pricing functional is due to Clark [2]. Note, though, that Clark does not restrict himself, as we do, to finite-dimensional contingent claim spaces. 1 demonstrates that markets are complete iff the valuation functional is unique.

In particular, the only limits on short selling were those implied by restrictions on consumption, if any were imposed. Short sales restrictions and transaction costs are important features of real-world security markets. In this chapter we introduce explicit portfolio restrictions and discuss the validity of the results of Chapters 2 and 3 under such restrictions. The simplest example of an explicit portfolio restriction arises when short sales of securities are limited. The general treatment of portfolio restrictions in this chapter allows us to determine the consequences of short sales restrictions, and also to model more complex portfolio restrictions, such as bid-ask spreads.

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