A game-theoretic derivation of the √(dt) effect

2018/02/04 by Vovk, Vladimir, Shafer, Glenn
#91G80 #FOS: Economics and business #Mathematical Finance (q-fin.MF)

paper · doi:10.48550/arxiv.1802.01219

Abstract

We study the origins of the √(dt) effect in finance and SDE. In particular, we show, in the game-theoretic framework, that market volatility is a consequence of the absence of riskless opportunities for making money and that too high volatility is also incompatible with such opportunities. More precisely, riskless opportunities for making money arise whenever a traded security has fractal dimension below or above that of the Brownian motion and its price is not almost constant and does not become extremely large. This is a simple observation known in the measure-theoretic mathematical finance. At the end of the article we also consider the case of non-zero interest rate. This version of the article was essentially written in March 2005 but remains a working paper.

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