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Economics Job Market Rumors - Forum for Economists. Felix Salmon | What I'm up to around the web. Contributing Editors' Blog Entries. TraderFeed. The Grumpy Economist. The Fundamental Theory of Asset Pricing. Within the field of Financial Mathematics, the Fundamental Theorem of Asset Pricing consists of two statements, (e.g. [Shreve, 2004, Section 5.4]) Theorem: The Fundamental Theorem of Asset Pricing 1. A market admits no arbitrage, if and only if, the market has a martingale measure. 2. The martinagale measure is unique, if and only if, every contingent claim can be hedged.
The theorem emerged between 1979 and 1983 ([Harrison and Kreps, 1979], [Harrison and Pliska, 1981],[Harrison and Pliska, 1983]) as Michael Harrison sought to establish a mathematical theory underpinning the well established Black-Scholes equation for pricing options. One remarkable feature of the Fundamental Theorem is its lack of mathematical notation, which is highlighted by the use of mathematical symbols in the Black-Scholes equation, which came out of economics. It is important to realise the fundamental position of probability in science. Two mathematical theories had become ascendant by the late 1920s.
The Psy-Fi Blog. The orthodox New Keynesian position on liquidity preference and loanable funds. I am not an orthodox New Keynesian macroeconomist (ONKM), but I can pretend to be one. Q: What determines the rate of interest? ONKM: "The central bank sets the rate of interest. " Discussion: the above answer is a pure liquidity preference theory of the rate of interest. By having a perfectly elastic money supply curve, at some rate of interest chosen by the central bank, the stock of money adjusts to equal whatever quantity of money is demanded at that rate of interest. Like in all liquidity preference theories, the rate of interest is determined by the demand for money and the supply of money. The only difference here is that the money supply curve is perfectly interest-elastic.
Q: But what determines where the central bank chooses to set the rate of interest? ONKM: "Loanable funds. " Discussion: this is the bit that needs some explanation. ONKM: "The central bank chooses to set the rate of interest that it believes is compatible with keeping output at potential and inflation on target. " A Fine Theorem. The Big Picture. Noahpinion. Keplerian Finance - exploring the boundaries of quantitative finance.