[2] It is a type of hypothetical asset used in the Arrow market structure model.
State prices may relatedly be applied in derivatives pricing and hedging: a contract whose settlement value is a function of an underlying asset whose value is uncertain at contract date, can be decomposed as a linear combination of its Arrow–Debreu securities, and thus as a weighted sum of its state prices; [3] [4] see Contingent claim analysis.
Breeden and Litzenberger's work in 1978 [5] established the latter, more general use of state prices in finance.
Imagine a world where two states are possible tomorrow: peace (P) and war (W).
The factors that affect these state prices are: If the agent buys both qP and qW, he has secured £1 for tomorrow.