I had this exercise and I calculated the prices of the Arrow Securities, π1 = 0.5 and π2 = -0.2. I know that π2 is not arbitrage-free because -0.2 < 0, but I do not understand that how to interpret this result or what the arbitrage strategy is and what its cash-flows are, as it is asked in part b) of the exercise.

I hope someone can help!

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  • 1
    $\begingroup$ Hint: The second Arrow Debreu security sounds incredibly good: By buying this one you could receive (!) 0.2 today; if State 1 occurs you owe nothing (good), if State2 occurs you receive another 1 dollar (super good). In other words you make some money today, you owe nothing in the future and maybe even make more money. That is one definition of an arbitrage. This Arrow Debreu security can be synthesized from the two available assets. $\endgroup$
    – nbbo2
    Jun 19, 2020 at 20:34
  • $\begingroup$ @noob2 Thank you a lot, now I got it! $\endgroup$
    – Phil
    Jun 22, 2020 at 12:23


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