Equilibrium returns with transaction costs

Bruno Bouchard (), Masaaki Fukasawa (), Martin Herdegen () and Johannes Muhle-Karbe ()
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Bruno Bouchard: Université Paris-Dauphine
Masaaki Fukasawa: Osaka University
Martin Herdegen: University of Warwick
Johannes Muhle-Karbe: Carnegie Mellon University

Finance and Stochastics, 2018, vol. 22, issue 3, No 2, 569-601

Abstract: 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.

Keywords: Equilibrium; Transaction costs; FBSDEs; 91G10; 91G80 (search for similar items in EconPapers)
JEL-codes: C68 D52 G11 G12 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (31)

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DOI: 10.1007/s00780-018-0366-6

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