A convenient way to characterize equivalent martingale measures in incomplete markets (Q1567084)

The authors present a convenient characterization of all possible equivalent martingale measures in relation to derivative prices. Mathematically, this characterization is not different from Radon-Nikodým derivatives of martingale measures with respect to objective probabilities, but it has some advantages. The main advantage is that pricing derivatives are split up into two steps. The first step is solving a related complete market pricing problem, and in the second step a weighted average of the first step complete market price must be calculated. As a consequence, a new definition of idiosyncratic risk is obtained, idiosynchratic information sets are described and the Hull-White formula for options on assets with idiosyncratic stochastic volatility is obtained under assumptions that are close to minimal ones. The authors discuss their assumptions in comparison with previous literature, give several examples and propose possible extensions.