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The Relationship between Arbitrage and First Order Stochastic Dominance
Author(s) -
JARROW ROBERT
Publication year - 1986
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1986.tb04556.x
Subject(s) - stochastic dominance , arbitrage , dominance (genetics) , joins , mathematical economics , characterization (materials science) , order (exchange) , mathematics , economics , fundamental theorem of asset pricing , arbitrage pricing theory , econometrics , financial economics , capital asset pricing model , computer science , finance , physics , biochemistry , chemistry , optics , gene , programming language
This paper joins together two fields of research in financial economics. The first field studies stochastic dominance, while the second field studies arbitrage pricing. The two fields are linked together through the derivation and the proof of a characterization theorem. The characterization theorem gives necessary and sufficient conditions for the existence of arbitrage opportunities in terms of the existence of two assets, one of which first order stochastically dominates the other and the price of a particular contingent claim. Examples are provided to demonstrate the theorem's content.