In the list of assumptions for the CAPM, one of them is that the market is perfect. In the Black-Scholes model, one of the assumptions is that the market is complete. What exactly do those things mean and are they the same thing? I realise I will probably just need to list them in an exam but it would be nice to understand what they mean as they sometimes ask you about how realistic assumptions are. Thanks in advance for any help.
A complete market is one in which a replicating startegy exists for any derivative - see the definition on page 8 in Chapter 13 in the Course Notes. In this course we just assume that the market for securities is complete (without proof) and hence the derivation of the Black-Scholes formula works. A perfect market is perfect is the sense of perfect competition as discussed in the CT7 (Economics) course. The main features are listed on page 3 in Chapter 5 of the Course Notes and include a very large number of rational and well-informed investors, none of whom is able to influence the market prices of securities, plus no taxes and transactions costs.
