Open Markets

TL;DR

This paper explores the properties and theoretical foundations of open markets, focusing on their structure, market viability, and portfolio construction, especially when access to the money market is restricted.

Contribution

It introduces a formal framework for open markets, analyzing their characteristics and extending classical financial models to this setting without assuming access to the money market.

Findings

Market viability and the existence of numeraire portfolios are equivalent in open markets with money market access.

Key financial concepts like CAPM and universal portfolios are adapted to open market settings.

The paper provides theoretical insights into portfolio construction in open markets.

Abstract

An open market is a subset of an entire equity market composed of a certain fixed number of top capitalization stocks. Though the number of stocks in the open market is fixed, the constituents of the market change over time as each company's rank by its market capitalization fluctuates. When one is allowed to invest also in the money market, the open market resembles the entire 'closed' equity market in the sense that the equivalence of market viability (lack of arbitrage) and the existence of numeraire portfolio (portfolio which cannot be outperformed) holds. When access to the money market is prohibited, some topics such as Capital Asset Pricing Model (CAPM), construction of functionally generated portfolios, and the concept of the universal portfolio are presented in the open market setting.