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Asymptotics and Duality for the Davis and Norman Problem

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  • Stefan Gerhold
  • Johannes Muhle-Karbe
  • Walter Schachermayer

Abstract

We revisit the problem of maximizing expected logarithmic utility from consumption over an infinite horizon in the Black-Scholes model with proportional transaction costs, as studied in the seminal paper of Davis and Norman [Math. Operation Research, 15, 1990]. Similarly to Kallsen and Muhle-Karbe [Ann. Appl. Probab., 20, 2010], we tackle this problem by determining a shadow price, that is, a frictionless price process with values in the bid-ask spread which leads to the same optimization problem. However, we use a different parametrization, which facilitates computation and verification. Moreover, for small transaction costs, we determine fractional Taylor expansions of arbitrary order for the boundaries of the no-trade region and the value function. This extends work of Janecek and Shreve [Finance Stoch., 8, 2004], who determined the leading terms of these power series.

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  • Stefan Gerhold & Johannes Muhle-Karbe & Walter Schachermayer, 2010. "Asymptotics and Duality for the Davis and Norman Problem," Papers 1010.0627, arXiv.org, revised Aug 2011.
    • Handle: RePEc:arx:papers:1010.0627
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    Cited by:

    1. Jin Hyuk Choi, 2013. "Asymptotic analysis for Merton's problem with transaction costs in power utility case," Papers 1309.3721, arXiv.org, revised Sep 2013.
    2. H. Mete Soner & Nizar Touzi, 2012. "Homogenization and asymptotics for small transaction costs," Papers 1202.6131, arXiv.org, revised Jun 2013.
    3. Dylan Possamai & H. Mete Soner & Nizar Touzi, 2012. "Homogenization and asymptotics for small transaction costs: the multidimensional case," Papers 1212.6275, arXiv.org, revised Jan 2013.
    4. Stefan Gerhold & Paolo Guasoni & Johannes Muhle-Karbe & Walter Schachermayer, 2011. "Transaction Costs, Trading Volume, and the Liquidity Premium," Papers 1108.1167, arXiv.org, revised Jan 2013.

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