Diversified Portfolios in Continuous Time

Abstract

Abstract We study a financial market containing an infinite number of assets, where each asset price is driven by an idiosyncratic random source as well as by a systematic noise term. Introducing ”asymptotic assets“ which correspond to certain infinitely well diversified portfolios we study absence of (asymptotic) arbitrage, and in this context we obtain continuous time extensions of atemporal APT results. We also study completeness and derivative pricing, showing that the possibility of forming infinitely well diversified portfolios has the property of completing the market. It also turns out that models where the all risk is of diffusion type are qualitatively quite different from models where one risk is of diffusion type and the other is of Poisson type. We also present a simple martingale based theory for absence of asymptotic arbitrage. JEL Classification: G12, G13,

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