Pseudorandom Financial Derivatives

Details Pseudorandom Financial Derivatives Pseudorandom Financial Derivatives

2010-06-02

arxiv.org/abs/1006.0469v7

Economy

Quantitative Finance

Computational Finance

11 pages

Scientific paper

Arora, Barak, Brunnermeier, and Ge showed that taking computational complexity into account, a dishonest seller could dramatically increase the lemon costs of a family of financial derivatives. We show that if the seller is required to construct derivatives of a certain form, then this phenomenon disappears. In particular, we define and construct pseudorandom derivative families, for which lemon placement only slightly affects the values of the derivatives. Our constructions use expander graphs. We study our derivatives in a more general setting than Arora et al. In particular, we analyze entire collateralized debt obligations (CDOs) when the underlying assets can have significant dependencies.

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