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Universit`a Commerciale “Luigi Bocconi”
Facolt`a di EconomiaMaster of Science in
FinanceSublinear and Locally Sublinear Prices
Relatore
Prof. Erio Castagnoli
Controrelatore
Prof. Fabio Maccheroni
Candidato
Alessandro Plasmati
1185198
Anno Accademico 2007/2008
 
Contents
1 Introduction52 Linear Functionals6
2.1 Criticism of Linear Prices. . . . . . . . . . . . . . . . . . . . . . . . 6
3 Sublinear Functionals7
3.1 Characterization. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73.1.1 Hahn-Banach Theorem. . . . . . . . . . . . . . . . . . . . . 73.1.2 General Representation of Sublinear Functionals. . . . . . . 93.1.3 Positivity of a Sublinear Functional. . . . . . . . . . . . . . 93.1.4 Monotonicity of a Sublinear Functional. . . . . . . . . . . . 10
4 A First (Sublinear) Extension of Linear Prices11
4.1 Setting. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114.2 No Arbitrage. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114.3 Sublinear Extensions of Linear Functionals in Incomplete Markets. 124.4 The Financial Perspective: Super-replication. . . . . . . . . . . . . 134.5 A complete example. . . . . . . . . . . . . . . . . . . . . . . . . . . 13
5 Sublinear Prices15
5.1 The Concept of “Convenient Super-replication”. . . . . . . . . . . . 165.2 The properties of the pricing functional and their consequences onthe internal coherence of prices. . . . . . . . . . . . . . . . . . . . . 175.3 The Role of Prices. . . . . . . . . . . . . . . . . . . . . . . . . . . . 185.4 Example. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195.4.1 Complete Market - Coherent Prices. . . . . . . . . . . . . . 195.4.2 Complete Market - Possible Super-replications. . . . . . . . 195.4.3 Complete Market - Arbitrages. . . . . . . . . . . . . . . . . 205.4.4 A further note. . . . . . . . . . . . . . . . . . . . . . . . . . 20
6 Frictions on the Riskless Asset22
6.1 The probability vector and discount factor in a sublinear market. . 226.2 Dynamics of Super-replications and of Arbitrage. . . . . . . . . . . 246.2.1 Prices without Frictions. . . . . . . . . . . . . . . . . . . . . 246.2.2 Prices with Frictions on the Risky Assets - No Frictions on
B 
246.2.3 Prices with Frictions on the Risky Assets and on
B 
. . . . . . 256.3 Possible Inversion of Discount Factors. . . . . . . . . . . . . . . . . 29
7 Beyond Sublinear Prices: Removal of Positive Homogeneity33
7.1 A Graphical Analysis of Sublinear Prices. . . . . . . . . . . . . . . . 337.2 Prices Increasing in Trade Size. . . . . . . . . . . . . . . . . . . . . 347.3 A Formal Argument for Sublinear Price Increments. . . . . . . . . . 357.4 Deriving State Prices when Market Prices are Coherent. . . . . . . 377.5 Super-replications in this Setting. . . . . . . . . . . . . . . . . . . . 407.5.1 Deriving
L
+
in this Market. . . . . . . . . . . . . . . . . . . 457.6 The Pricing Functional with Multiple Price Changes. . . . . . . . . 47
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