The impact of transaction costs on state-contingent claims mispricing

Valerio Restocchi, Frank McGroarty, Enrico Gerding and Johnnie E.V. Johnson

Finance Research Letters, 2017, vol. 23, issue C, 174-178

Abstract: We analyze the impact that transaction costs have on asset mispricing in state-contingent claims markets. In particular, we examine betting markets, in which, it has been argued, transaction costs cause the favorite-longshot bias, a pricing anomaly analogous to the volatility smile in options markets. By using a heterogeneous agents model, we prove that transaction costs alone cannot cause mispricing. Also, we run agent-based simulations to character- ize the response of market prices to increments in transaction costs. We find that transaction costs have a significant impact on market inefficiency, by amplifying existing mispricing both directly, influencing market prices, and indirectly, inducing a non-linear response from the agents.

Keywords: Transaction costs; Pricing anomalies; Heterogeneous agents; State-contingent claims; Favorite-longshot bias (search for similar items in EconPapers)
JEL-codes: D4 G1 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:23:y:2017:i:c:p:174-178

DOI: 10.1016/j.frl.2017.02.006

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