Regulations impose idiosyncratic capital and funding costs for holding derivatives. Idiosyncratic costs mean that no single measure makes derivatives martingales for all market participants. Chris Kenyon and Andrew Green demonstrate that regulatory-compliant pricing cannot be risk neutral, which in turn has implications for exit prices and mark-to-market CLICK HERE TO VIEW THE PDF Increased regulation and market changes since 2007 have altered the perceived costs of many financial products. Here we prove that these changes are not just perception: they have had a fundamental effect on pricing theory. That is, we prove a market-wide risk-neutral measure that is common to all participants does not exist. This proof is based on our theorem 2, which states that if different market participants receive different dividends for holding the same stock, then there is no market-wide risk-neutral measure that is common to all market participants. We then demonstrate that because of regulations and unhedgeable risks, different trading businesses have different holding costs for the same positions. This means that all valuations are private, in the sense that they can be derived from idiosyncratic risk-neutral measures (that is, the valuations are local to the individual pricing institution). Executable screen prices are components of value, not valuations by themselves, because of these idiosyncratic and asymmetric costs....
Start a FREE trial or subscribe to continue reading:
Start a 4 week free trial
Try Risk.net's premium content for a limited period. Register now for your FREE trial to one of our leading brands.
*not available to previous trialists or subscribers.
Log In or Subscribe Now
Subscribe to Risk.net Business now to access all our premium news & features content for 1 year.
Pay by Credit Card for immediate access.