Law of one price


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Law of one price

An economic rule stating that a given security must have the same price no matter how the security is created. If the payoff of a security can be synthetically created by a package of other securities, the implication is that the price of the package and the price of the security whose payoff it replicates must be equal. If it is unequal, an arbitrage opportunity would present itself.

Absolute Form of Purchasing Power Parity

A theory stating that the same good or service costs the same amount regardless of the currency in which it is measured. For instance, if 1 pound is equivalent to 2 dollars, and a widget costs 1 pound in England, then the absolute form of purchasing power parity would state that the same widget would cost 2 dollars in the United States. This concept is also called the law of one price. In securities, any deviations from the absolute form of purchasing power parity create opportunities for arbitrage (profiting from inefficiencies in prices). See also: Purchasing power parity, Currency pair.
References in periodicals archive ?
Wei (1996) Convergence to the Law of One Price Without Trade Barriers or Currency Fluctuations.
In the models of Friberg (2001) and Anderton, Baldwin, and Taglioni (2003), price differentials can move within a range without threat of arbitrage, but outside this range, arbitrage pushes prices back toward the law of one price.
Threshold Adjustment of Deviations from the Law of One Price.
It is a long way from the law of one price to PPP, for the law of
Asplund and Friberg (2001) likewise find that a given good in a given duty-free shop often sells at different prices quoted in different currencies, contrary to what the law of one price would have predicted.
Assuming that the law of one price holds for traded goods, a higher relative price of nontraded goods in this country raises this country's price level relative to that abroad.
Consequently, price indices and ratios that contain nontraded components can easily exhibit persistent deviations from what would be expected under the law of one price (Balassa 1964; Samuelson 1964).
Baffes, John (1991) Some Further Evidence on the Law of One Price: The Law of One Price Still Holds.
ss] represent the prices of sesame seeds in Britain (in pounds) and the United States (in dollars), respectively, then the law of one price can be expressed as follows:
Empirical evidence using disaggregated data suggests that international markets for tradable goods remain highly segmented and that deviations in the law of one price are large, persistent, and highly correlated with movements in the nominal exchange rate, even for highly tradable goods.
He argues that some modern mathematical renditions of classical monetary theory view matters through the Ricardian Telescope by making the law of one price hold continuously.
Baulch (1997) identifies four econometric approaches for measuring spatial market integration, namely, law of one price (LOP), the Ravallion model, Granger-causality and cointegration tests.