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Equilibrium Returns with Transaction Costs

Bruno Bouchard, Masaaki Fukasawa, Martin Herdegen and Johannes Muhle-Karbe
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Bruno Bouchard: CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris-Dauphine - CNRS - Centre National de la Recherche Scientifique
Masaaki Fukasawa: Osaka University [Osaka]
Martin Herdegen: University of Warwick [Coventry, UK]
Johannes Muhle-Karbe: University of Michigan [Ann Arbor]

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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; liquidity premium (search for similar items in EconPapers)
Date: 2018
Note: View the original document on HAL open archive server: https://hal.archives-ouvertes.fr/hal-01569408v3
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Published in Finance and Stochastics, Springer Verlag (Germany), 2018, 22 (3), pp.569-601

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