The basic assumptions of prices of assets

The basic assumptions we use to define an underlying (stock and stock indices) price, regarded as the basis of the discussion in this paper are as follows:

(i) There are prices (the cost price and the market price) to an underlying assert. The cost price means the average of all the prices paid by the market traders to buy an underlying asset and the market price is the current exchange price of an underlying asset.

(ii) The prices (cost price and market price) have been fluctuating with time. Any price and the fluctuation spread (i.e. the variance) of price are non-negative.

(iii) Both the cost price and the fluctuation of cost price of an underlying are the basic elements of determining the market prices of the underlying; The market prices come into being on the market exchange.

(iv) The possibilities that the market price of underlying is much lower than the cost price, or is much higher than the cost price, will be very small.

(v) When the market price drifts gradually apart from the cost price, the possibility that the price of making a trade steps down gradually.

(vi) All securities are perfectly divisible.

(vii)There are no transaction costs or taxes.

We shall prefer referring to stock instead of asset, at the same time, the stock can also be replaced by stock indices, and we mention no more in the following discussions.

Prof. Feng Dai, Prof. Zifu Qin

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