What do Arbitrage Free Models describe?

Arbitrage Free Models are designed to describe the price relationships between assets without the opportunity for arbitrage. In essence, these models suggest that the price of one asset (or a group of assets) should be relative to the price of another asset or a basket of assets, accounting for the time value of money and risk. This means that if two assets are theoretically equal in risk and future cash flows, their prices should not diverge significantly. Arbitrage opportunities arise when there is a discrepancy in pricing that allows traders to profit from buying low and selling high; however, Arbitrage Free Models prevent such opportunities by ensuring that prices reflect all available information accurately and consistently.

The other options do not align with the specific focus of Arbitrage Free Models. While historical average prices (option B) and price trends over time (option C) may provide insights into market behaviors, they do not encapsulate the essence of arbitrage-free pricing relationships. Option D, concerning price manipulation by external forces, is contrary to the foundational concept of these models, which assumes that prices reflect fair market values without artificial interference. Thus, the association of prices relative to other assets is the key characteristic of Arbitrage Free Models.