A General Equilibrium Financial Asset Economy With Transaction Costs And Trading Constraints

Frank Milne and Edwin H. Neave
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Edwin H. Neave: Queen's University

No 1082, Working Paper from Economics Department, Queen's University

Abstract: This paper presents a unified framework for examining the general equilib-rium effects of transactions costs and trading constraints on security markettrades and prices. The model uses a discrete time/state framework and Kuhn-Tucker theory to characterize the optimal decisions of consumers and financial intermediaries. Transaction costs and constraints give rise to regions of no trade and to bid-ask spreads: their existence frustrate the derivation of standard results in arbitrage-based pricing. Nevertheless, we are able to obtain as dualcharacterisations of our primal problems, one-sided arbitrage pricing resultsand a personalised martingale representation of asset pricing. These pricingresults are identical to those derived by Jouini and Kallal (1995) using arbitrage arguments. The paper's framework incorporates a number of specialised existing models and results, proves new results and discusses new directions for research. In particular, we include characterisations of intermediaries who hold optimal portfolios; brokers who do not hold portfolios, and consumer-specifictransactions costs and trading constraints. Furthermore we show that in the special case of equiproportional transaction costs and a sufficient number of assets, there is an analogue of the arbitrage pricing result for European derivatives where prices are interpreted as mid-prices between the bid-ask spread. We discuss the effects of non-convex transaction technologies on prices and trades.

Keywords: Financial Markets; Transaction Costs; Trading Constraints; Asset Pricing; General Equilibrium; Incomplete Markets (search for similar items in EconPapers)
JEL-codes: D52 G12 G13 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2003-09
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

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