Portfolio Selection with Transaction Costs and Default Risk

Giovanni Puopolo

CSEF Working Papers from Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy

Abstract: I propose a simple consumption/investment problem with transaction costs and default risk. When default occurs, I assume the value of the risky asset drops to zero and the investor receives the terminal wealth only in the form of the other (riskless) security. I show that default risk can generate a first-order effect on the investor’s asset allocation. On the contrary, the liquidity premium is one order of magnitude smaller than the transaction costs, implying that the additional source of risk determined by the possibility of default is not able to generate a first-order effect on asset pricing.

JEL-codes: C61 D11 D91 G11 (search for similar items in EconPapers)
Date: 2015-09-20
New Economics Papers: this item is included in nep-cfn and nep-rmg
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Published in Managerial Finance, 43, 2, pp. 231-241

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