STOCHASTIC-DOMINANCE, PARETO OPTIMALITY, AND EQUILIBRIUM ASSET PRICING

This paper introduces the concept of a factor subspace in competitive equilibrium asset pricing. A factor subspace contains the market portf olio and is such that every marketed contingent claim is second-order stochastically dominated by a claim from the factor subspace. Conditio ns are given for the existence of equilibrium, and it is shown how APT and CAPM can be interpreted in the framework of the paper. If suffici ently many call options on the market portfolio are traded, then the s pace spanned by these options can be used as the factor subspace.