Inter-temporal asset pricing in general equilibrium with arbitrage opportunities

This thesis develops general equilibrium with arbitrage opportunities and considers its asset pricing implications. We show numerically that if the trading of the stock and its derivative is constrained then a general competitive equilibrium with states where Sharpe ratios of two risky securities are different can exist. We characterize asset prices in such an equilibrium and show that it admits arbitrage opportunities for a price taking speculator. If the equilibrium does not admit states with arbitrage, then the derivative always costs the Black-Scholes price. We show that the equilibrium approach predicts arbitrage opportunities in states of the market where the existing no-arbitrage approach for pricing a contingent claim in the market with frictions does not. To identify all arbitrage opportunities we introduce the upper and lower hedging portfolios of the derivative which contain the derivative itself. We find the states in which the values of hedging portfolios are different and show that these states allow a free lunch. Finally we show that a speculator with a finite risk aversion prefers more risk exposure instead of taking maximal position in arbitrage. Moreover, while an arbitrageur has a choice between investing into risky and riskless arbitrage he will always trade only riskless arbitrage