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Equilibrium returns with transaction costs

Author

Listed:
  • Bruno Bouchard

    (Université Paris-Dauphine)

  • Masaaki Fukasawa

    (Osaka University
    Tokyo Metropolitan University)

  • Martin Herdegen

    (University of Warwick)

  • Johannes Muhle-Karbe

    (Carnegie Mellon University)

Abstract

We study how trading costs are reflected in equilibrium returns. To this end, we develop a tractable continuous-time risk-sharing model, where heterogeneous mean–variance investors trade subject to a quadratic transaction cost. The corresponding equilibrium is characterized as the unique solution of a system of coupled but linear forward–backward stochastic differential equations. Explicit solutions are obtained in a number of concrete settings. The sluggishness of the frictional portfolios makes the corresponding equilibrium returns mean-reverting. Compared to the frictionless case, expected returns are higher if the more risk-averse agents are net sellers or if the asset supply expands over time.

Suggested Citation

  • Bruno Bouchard & Masaaki Fukasawa & Martin Herdegen & Johannes Muhle-Karbe, 2018. "Equilibrium returns with transaction costs," Finance and Stochastics, Springer, vol. 22(3), pages 569-601, July.
    • Handle: RePEc:spr:finsto:v:22:y:2018:i:3:d:10.1007_s00780-018-0366-6
    DOI: 10.1007/s00780-018-0366-6
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    References listed on IDEAS

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    More about this item

    Keywords

    Equilibrium; Transaction costs; FBSDEs;
    All these keywords.

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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