Market Completeness Flashcards
1
Q
What is Market Completeness
A
A market is complete if every possible future payoff can be replicated exactly by trading available assets.
In simpler terms:
You can build a portfolio (using stocks, bonds, options, etc.) to mimic any desired future outcome.
If you can’t do this, the market is incomplete.
2
Q
Why is market completeness important?
A
In complete markets, there is only one unique way to price risk and assets.
You get a unique stochastic discount factor (SDF) or state price.
In incomplete markets, multiple discount factors can price the same asset — pricing becomes ambiguous.
This matters for:
-Derivatives pricing
-No-arbitrage pricing
-Theoretical foundations like CAPM, APT, and Euler equations
3
Q
What to watch out for.
A
