Universal Contingent Claims and Multiplicative Measures
by
Valery A. Kholodnyi
Reliant Resources, Inc.

We present the concept of a universal contingent claim introduced by the author in 1995. This concept provides a unified framework for the analysis of a wide class of financial derivatives.

A universal contingent claim describes the time evolution of a contingent payoff. In the simplest case of a European contingent claim this time evolution is given by a family of nonnegative linear operators, the valuation operators. For more complex contingent claims, this time evolution, given by the valuation operators, can be interrupted by discrete or continuous activation of external influences that are described by, generally speaking, nonlinear operators, the activation operators. For example, Bermudan and American contingent claims represent discretely and continuously activated universal contingent claims with the activation operators being the nonlinear maximum operators.

We show that the value of a universal contingent claim is given by a multiplicative measure introduced by the author in 1995. Roughly speaking, a multiplicative measure is an operator-valued (in general, an abstract measure with values in a partial monoid) function on a semiring of sets which is multiplicative on the union of disjoint sets. We also show that the value of a universal contingent claim is determined by a, generally speaking, impulsive semilinear evolution equation.

Date received: October 14, 2002