Arbitrage-Free Valuation Models

Which of Caitlin’s assumptions about the arbitrage-free valuation framework is _least accurate_?

That's it! This assumption isn't accurate. In a well-functioning market, prices adjust until there are no arbitrage opportunities. There would be no arbitrage opportunities in a perfectly efficient market, but in a well-functioning market they may exist until prices adjust.

Incorrect. This assumption is actually accurate. The implication of the law of one price is that taking on zero risk should result in zero expected return.

Incorrect. This assumption is accurate. The arbitrage-free valuation approach doesn't allow a market participant to realize an arbitrage profit through stripping and reconstitution of cash flows.

Assumption 1

Assumption 2

Assumption 3