Inherent Efficiency, Security Markets, and the Pricing of Investment Strategies

This paper applies the dichotomous theory of choice by Zou (2000a) to the analysis of investment strategies and security markets. Issues concerning individual optimality, (approximate) arbitrage, capital market equilibrium, and Pareto efficiency are studied under various market conditions. <BR> Among the main results are <OL> <LI>a unique dichotomous pricing model, unifying and generalizing the existing models, that can be used for pricing any financial securities under both complete and incomplete markets, <LI>conditions for individual optimality that hold for general utilities (including expected utility as a special case), <LI>the existence and uniqueness of capital market equilibrium, and <LI>implications of capital market equilibrium, including a separation theorem, inherent efficiency of the market portfolio, Pareto efficiency, and several testable hypotheses that predict securities' equilibrium up-market potentials and down-market potentials, respectively. </OL> <BR><BR>