Arrow Debreu Model

Arrow-Debreu Model is a fundamental model used in the General Equilibrium Theory. The model derived its name from two eminent economists Kenneth Arrow from America and Gerard Debreu from France.
These two world famous economists have studied the dynamics of the prevailing economic system and shown that a multimarket equilibrium is prevailing and in this equilibrium, surplus demand or surplus supply has no existence. This model is also popularly knwon as Arrow-Debreu-McKenzie model or ADM model.

Arrow-Debreu Model is built upon two different assumptions. According to the first assumption, there is enough possibility of an equilibrium of competitive nature but the condition is that everyone in the economy should have at least some amount of every kind of available goods in their holdings.

According to the second assumption, there is a huge amount of labor resources available in the market that can be utilized for producing the required commodities and services.
Arrow-Debreu Model is capable of analyzing the exact situations of those markets that are very competitive. In the field of financial economics, Arrow Debreu represents a certain kind of securities product.. The Arrow-Debreu security is a distinguished concept that is very helpful for understanding the analysis of the derivatives. By using this particular model, one can easily understand the activities like pricing and hedging that are also related to the derivative analysis. On the other hand, the Arrow-Debreu Model is also used in areas like financial engineering and many more. Although the theory was criticized by various eminent economists, but the truth is that the Arrow-Debreu Model is very important for the derivative industry and helps the industry to grow at a rapid pace.

At present, Basis Instrument Contracts, that is a kind of derivative contract, is becoming very popular. This concept is tractable enough and is providing the Black Scholes’ analysis a new dimension. At the same time, the Basis Instrument Contracts is also applying the analysis of Black Scholes’ in different markets. Basis Instrument Contracts is playing a major role in popularizing the Arrow-Debreu security.

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Interest Rate Risk Settlement Risk Equity Risk
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Last Updated on : 1st July 2013