Introduction to a theory of value coherent with the no-arbitrage principle (Q5926468)

Let \(w\) be a time-\(T\) claim that one wants to evaluate. The function \(u\) is the time-\(T\) utility (i.e. utility from time \(T\) wealth). In totally incomplete market the possibility of trading in the available marketed assets does not provide any help for hedging the risk carried by \(w\). In this case the subjective value of \(w\) is traditionally assigned by the amount \(\pi(w)\in R\) the utility of which is equal to the expected utility of the claim \(w\), \(u(\pi(w))=E[u(w)]\). The agent can not take advantage of the presence of the marketed securities. In complete market or if a bounded claim \(w\) is attainable by a self-financing strategy in the marketed assets, the value of the claim is independent from agents preferences and it is univocally assigned by the formula \(\pi(w)=E_{Q}[w]\), where \(Q\) is any martingale measure (eventually unique if the market is complete). The complete market case is very particular. In incomplete market, in order to determine the value of the claim, the agent has to take into consideration his subjective preferences. However, he may partially hedge the risk carried by \(w\) by trading in the available securities. The presence of these securities will affect the valuation of the claim. Indeed, the no arbitrage principle imposes restrictions on the admissible prices: in order to prevent arbitrage opportunities the value of \(w\) must lie in the interval \([\inf_{Q}E_{Q}[w]\), \(\sup_{Q}E_{Q}[w]]\). The aim of this paper is to construct a theory of value based on agents preferences and coherent with the no arbitrage principle. This value is a nontrivial extension of the certainty equivalent since it takes into consideration the possibility of partially hedging the risk carried by the claim.