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The Economics of Business ValuationTowards a Value Functional Approach$
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Patrick Anderson

Print publication date: 2013

Print ISBN-13: 9780804758307

Published to Stanford Scholarship Online: September 2013

DOI: 10.11126/stanford/9780804758307.001.0001

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ARBITRAGE-FREE PRICING IN COMPLETE MARKETS

ARBITRAGE-FREE PRICING IN COMPLETE MARKETS

Chapter:
(p.126) (p.127) 10 ARBITRAGE-FREE PRICING IN COMPLETE MARKETS
Source:
The Economics of Business Valuation
Author(s):

Patrick L. Anderson

Publisher:
Stanford University Press
DOI:10.11126/stanford/9780804758307.003.0010

The author describes one of the breakthrough concepts of modern finance: the use of the no arbitrage principle in complete markets as the basis for the powerful mathematics of “risk neutral” or “equivalent martingale” pricing. This neoclassical finance model relies on two intertwined assumptions: the existence of complete markets, and the assumption that market participants will act to ensure that no arbitrage profits are possible. The author then presents strong evidence that both of these assumptions are lacking for private businesses and their investors, because markets for the equity in these firms are incomplete. The author argues that this severely undermines this model as a practical valuation tool. As with other principles, this assertion is tested by applying it to three actual companies.

Keywords:   neoclassical finance, no-arbitrage principle, arbitrage free pricing, risk neutral, First Fundamental Theorem of Finance, equivalent martingale, complete markets, incomplete markets, state pricing

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