Good Deals and Compatible Modification of Risk and Pricing Rule: A Regulatory Treatment

In this paper, we consider an expectation bounded risk measure and an arbitrage-free market with pricing rule . We introduce the concept of compatibility and show that the lack of compatibility leads to meaningless situations in financial or actuarial applications. Compatibility is characterized by the existence of Stochastic Discount Factors (SDF) of in the sub-gradient of . Furthermore, it is equivalent to ruling out the Good Deals or having No Good Deal. Several examples are discussed and it is pointed out that lack of compatibility occurs in very important pricing models that have been proposed in the literature. We also discuss ways of choosing the best discount factor, when some external criteria are satisfied or No Better Choice pricing method is applied for Global Risk

compatibility; compatible extension; no good deal; cvar; ccvar; capm; heston model; stochastic discount factor; external risk; no better choice; global risk; global/local ratio

Good Deals and Compatible Modification of Risk and Pricing Rule: A Regulatory Treatment Articles