General Equilibrium Asset Pricing

Under General equilibrium theory prices are determined through market pricing by supply and
demand. Here asset prices jointly satisfy the requirement that the quantities of each asset
supplied and the quantities demanded must be equal at that price - so called market clearing.
These models are born out of modern portfolio theory, with the Capital Asset Pricing Model
(CAPM) as the prototypical result.

Prices here are determined with reference to macroeconomic variables - for the CAPM, the
"overall market"; for the CCAPM overall wealth - such that individual preferences are subsumed.
General equilibrium pricing is then used when evaluating diverse portfolios, creating one asset
price for many assets. [4]

Calculating an investment or share value here, entails a financial forecast for the business or
project in question, where the output cashflows are then discounted at the rate returned by the
model selected; this rate in turn reflecting the "riskiness" of these cashflows. See Financial
modeling#Accounting, Valuation using discounted cash flows. (Note that an alternate, although
less common approach, is to apply a "fundamental valuation" method, such as the T-model,
which instead relies on accounting information, attempting to model return based on the
company's expected financial performance.)

Rational Pricing

Under Rational pricing, (usually) derivative prices are calculated such that they are arbitrage-
free with respect to more fundamental (equilibrium determined) securities prices. For further
discussion, see Mathematical finance #Derivatives pricing: the Q world; for an overview of the
logic, see Rational pricing #Pricing derivatives.

Calculating option prices (or their "Greeks") combines a model of the underlying price behavior
(or "process") - ie the asset pricing model selected - with a mathematical method which returns
the premium (or sensitivity) as a function of this behavior. See Valuation of options #Pricing
models. Rational pricing is then used for fixed incomes or bonds that consist of just one asset.
This solution does not group assets but rather creates a unique risk price for each asset.

The classical model here is Black–Scholes which describes the dynamics of a market including
derivatives (with its option pricing formula); leading more generally to Martingale pricing, as
well as the aside models. Black–Scholes assumes a log-normal process; the other models will, for
example, incorporate features such as mean reversion, or will be "volatility surface aware".

Interrelationship

These principles are interrelated through the Fundamental theorem of asset pricing. Here, "in
the absence of arbitrage, the market imposes a probability distribution, called a risk-neutral or
equilibrium measure, on the set of possible market scenarios, and... this probability measure
determines market prices via discounted expectation". [5]

Correspondingly, this essentially means that one may make financial decisions, using the risk
neutral probability distribution consistent with (i.e. solved for) observed equilibrium prices. See
Financial economics #Arbitrage-free pricing and equilibrium.