= Exact factor pricing without a traded risk-free asset
{title2=$\mathbb E r=\lambda_0\mathbf1+B\lambda$}
Suppose <asset returns> have the exact representation $r=a+Bf$, allowing unrestricted long and short <portfolios>. A position $v$ with $\mathbf1^Tv=0$ and $B^Tv=0$ costs zero and has constant <financial payoff> $a^Tv$. Absence of <arbitrage> therefore forces $a^Tv=0$, since either sign of $v$ is allowed. The <orthogonal complement> identity gives $a\in\operatorname{span}(\mathbf1,\operatorname{col}B)$. Taking <expectations> proves the displayed pricing relation, with $\lambda$ equal to the coefficients of $B$ in $a$ plus $\mathbb E f$. When $[\mathbf1\ B]$ has full column <rank>, $\lambda_0$ is the return of a unit-cost zero-exposure <portfolio> and $\lambda_j$ is the <expected return> of a zero-cost <portfolio> with exposure one to factor $j$ and zero to the others. Without that <rank> condition the coefficients need not be unique, and a traded zero-exposure <portfolio> need not exist.
Back to article page
