Good deals in markets with frictions

Beatriz Balbás and Raquel Balbás

DEE - Working Papers. Business Economics. WB from Universidad Carlos III de Madrid. Departamento de Economía de la Empresa

Abstract: This paper studies a portfolio choice problem such that the pricing rule may incorporate transaction costs and the risk measure is coherent and expectation bounded. We will prove the necessity of dealing with pricing rules such that there are essentially bounded stochastic discount factors, which must be also bounded from below by a strictly positive value. Otherwise good deals will be available to traders, i.e., depending on the selected risk measure, investors can build portfolios whose (risk, return) will be as close as desired to (- infinite, + infinite) or (0, infinite). This pathologic property still holds for vector risk measures (i.e., if we minimize a vector valued function whose components are risk measures). It is worthwhile to point out that essentially bounded stochastic discount factors are not usual in financial literature. In particular, the most famous frictionless, complete and arbitrage free pricing models imply the existence of good deals for every coherent and expectation bounded measure of risk, and the incorporation of transaction costs will no guarantee the solution of this caveat

Keywords: Risk; measure; Perfect; and; imperfect; markets; Stochastic; discount; factor; Portfolio; choice; model; Good; deal (search for similar items in EconPapers)
JEL-codes: G11 G12 G13 (search for similar items in EconPapers)
Date: 2011-02
New Economics Papers: this item is included in nep-agr and nep-rmg
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