Market Efficiency, Risk Neutral Pricing and Choice Among Representations: a "mini-model"
Résumé
The so-called “risk-neutral probability” is a technical tool that has received considerable attention in financial practices over the past thirty years, to the
point that risk-neutral pricing techniques are now a routine part of the day-to-day business in the finance industry. I present an simplified “mini-model”
of risk-neutral pricing to allow the black box to be opened to philosophical investigation by displaying without any mathematics the fair value pricing
mechanism in a complete arbitraged free market. I argue that the difficulties of the puzzling methods used to value financial assets using risk-neutral valuation techniques are more conceptual than mathematical, and discuss the epistemological issues enlightened by this mini-model, particularly in terms
of narratives. The mini-model reveals how the Efficient Markets Hypothesis (EMH) is a narrative imposed on the real finance, and how the EMH narratives
correspond to each other as quantification conventions which draws a “representation format” of EMH. It raises the ethical question of choosing
a narrative for financial purposes, particularly when ethical, climatic and environmental issues are at stake.
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