While skeeming the relevant literature and web-sites I noticed that mostly the concept of the incomplete market is reduced to the following statement

"A market is incomplete if there are more sources of noise than tradeable assets"

This might work well as a rule of thumb but does not really explain the underlying consequences (e.g. what it actually means for the market participants) - also it doesn't aid in visualizing understanding the concept.

I tried to find a comprehensive and easily accessible reference on the topic online but was unsuccessfull. Thus I thought qaunt SE is the perfect place to colaborate on one!

Explain/Illustrate: What is an icomplete market in a quant finance sense ?

  • examples on how a hedges might not work
  • explanation via Arrow-Debtreu securities and exchange of risk
  • reading suggestions/literature references
  • how can a market be completed (e.g. introduction of a volatility index that can be traded etc.)
  • $\begingroup$ A good reference is "Föllmer, H. and Schied, A. (2002). Stochastic Finance: An Introduction in Discrete Time, de Gruyter Series in Mathematics 27, Berlin". Whether it is "easily accessible" or not is of course a matter of subjective taste. It covers the first two bullet points comprehensively. $\endgroup$ – g g Feb 28 '14 at 16:26
  • $\begingroup$ why not write that as answer ;) - I will also add my own take on the subject later $\endgroup$ – Probilitator Feb 28 '14 at 16:32
  • $\begingroup$ I don't remember the exact source, but I think Duffie wrote a nice paper (maybe the original one?) on Arrow-Debreu securities and equilibria in an incomplete market. $\endgroup$ – quasi Feb 28 '14 at 18:34
  • $\begingroup$ @quasi I will do some digging ;) $\endgroup$ – Probilitator Feb 28 '14 at 18:42
  • $\begingroup$ @Probilitator: This is a link only reply, which are supposed to be provided in comments as per policy. I learned this the hard way :-) i.e. one of my answers got removed. $\endgroup$ – g g Mar 3 '14 at 13:17

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