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Equilibrium Returns with Transaction Costs

Author

Listed:
  • Bruno Bouchard

    (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris Dauphine-PSL - PSL - Université Paris Sciences et Lettres - CNRS - Centre National de la Recherche Scientifique)

  • Masaaki Fukasawa

    (Osaka University [Osaka])

  • Martin Herdegen

    (University of Warwick [Coventry])

  • Johannes Muhle-Karbe

    (University of Michigan [Ann Arbor] - University of Michigan System)

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," Post-Print hal-01569408, HAL.
    • Handle: RePEc:hal:journl:hal-01569408
    Note: View the original document on HAL open archive server: https://hal.science/hal-01569408v3
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    References listed on IDEAS

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