Risk measures on incomplete markets: a new non-solid paradigm

Abstract

The abstract theory of risk measures is well-developed for certain classes of solid subspaces of $L^{0}$. We provide an example to illustrate that this framework is insufficient to deal with the subtleties of incomplete markets. To remedy this problem, we consider risk measures on the subspace generated by a closed, absolutely convex, and bounded subset $K\subset L^{0}$, which represents the attainable securities. In this context, we introduce the equicontinuous Fatou property. Under the existence of a certain topology $\tau$ on $\mathrm{span}(K)$, interpreted as a generalized weak-star topology, we obtain an equivalence between the equicontinuous Fatou property, and lower semicontinuity with respect to $\tau$. As a corollary, we obtain tractable dual representations for such risk measures, which subsumes essentially all known results on weak-star representations of risk measures. This dual representation allows one to prove that all risk measures of this form extend, in a maximal way, to the ideal generated by $\mathrm{span}(K)$ while preserving a Fatou-like property.