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Consider an incomplete market $(\Omega,\mathcal F,\mathbb P)$ driven by a semimartingale $S=(S_t)_{t\in[0,T]}$. Under the no free lunch under vanishing risk (NFLVR) assumption, the set $\mathcal P^\ast$ of equivalent martingale measures under which $S$ is a semi-martingale is not empty: $$ \mathcal P^\ast\neq\emptyset,\quad\mathbb P^\ast\sim\mathbb P,\enspace \forall \mathbb P^\ast \in \mathcal P^\ast. $$

Denote densities $$ Z_{\mathbb{P^*}}=\frac{d\mathbb P^\ast}{d\mathbb P},\quad \text{for }\mathbb P^\ast\in \mathcal P^\ast, $$

and the set of densities $$Z_{\mathcal{P^\ast}}=\\{Z_{\mathbb{P^\ast}}\ :\ \mathbb P^\ast\in \mathcal P^\ast\\}$$

Now, a certain theorem (a generalized version of the Neyman-Pearson lemma) requires that $Z_{\mathcal P^\ast}$ is compact in $L^1(\Omega,\mathcal F,\mathbb P)$. I would like to see how restricting this assumption is by trying to provide an incomplete market example (i.e., a model where $\mathcal P^\ast$ is not a singleton) where $Z_{\mathcal P^\ast}$ is compact. However, I haven't been able to do so.

I first tried the discrete-time one-period trinomial model, in which the set of martingale measures and the set of associated densities represent convex polyhedrons. However, due to the measure equivalence requirement, the polyhedron is open (at the extreme points, one or more nodes will have zero probability, hence the extreme points are excluded along with the entire boundary). Therefore, it is not compact?

Next thing, I tried the continuous-time jump-diffusion model. The set of equivalent martingale measures can be parametrized with two real numbers, and the Radon-Nikodym derivative can be written down explicitly, however I have no idea how to approach the problem of verifying the compactness property.

Could someone provide an example of an incomplete market (discrete-time or continuous-time) where the set of densities is compact?

Also, my skills in functional analysis are pretty basic, so I would be glad to see any criterions or sufficient conditions of compactness in $L^1$ applicable to this problem.

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Crossposted to MO: mathoverflow.net/questions/101057/… –  user16299 Jul 1 '12 at 11:04

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