Journal of Risk

Arbitrage, martingales, and private monetary value

Robert A. Jarrow, Dilip B. Madan


This paper reevaluates the mathematical and economic meaning of no arbitrage in frictionless markets. Contrary to the traditional view, no arbitrage is not generally equivalent to the existence of an equivalent martingale measure. Departures from this equivalence allow asset prices to contain a monetary component. The refined view is that no arbitrage and no private monetary value components are equivalent to the existence of an equivalent martingale measure. The implications of prices having a monetary value component for option pricing are discussed.

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