Nuclear Financial Economics

An important subfield of physics — Nuclear Physics — deals with the smallest particles of which matter is composed. Constructs developed by Kenneth Arrow (2) and Gerard Debreu (3) provide a similar foundation for financial economics. With a bit of hyperbole, the approach may be termed nuclear financial economics. In their pioneering work, Arrow Debreu explored aspects of general equilibrium. After dealing with the economists’ then-traditional world of certainty, they turned to issues related to risk. Here we show how the Arrow-Debreu approach can be used to analyze risk in the domains of financial engineering, corporate finance, and investment analysis. The simplest possible cases, involving only two time periods (the present and a future date) are employed. While the results are quite general, no attempt is made to prove generality nor to extend the analyses to cover more complex cases. The relatively modest goal of the paper is to whet the appetite of the reader to consider the use of “nuclear financial economics” when analyzing issues involving risk in financial settings.