The Relationship between Arbitrage and First Order Stochastic Dominance

  • Author(s): ROBERT JARROW
  • Published: Apr 30, 2012
  • Pages: 915-921
  • DOI: 10.1111/j.1540-6261.1986.tb04556.x

ABSTRACT

This paper joins together two fields of research in financial economics. The first field studies stochastic dominance, while the second field studies arbitrage pricing. The two fields are linked together through the derivation and the proof of a characterization theorem. The characterization theorem gives necessary and sufficient conditions for the existence of arbitrage opportunities in terms of the existence of two assets, one of which first order stochastically dominates the other and the price of a particular contingent claim. Examples are provided to demonstrate the theorem's content.

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