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Equilibrium Returns with Transaction Costs

21. December 2017
Kategorie: 
Research Seminars
Rudower Chaussee 25, Room 1.115, 5 p.m.
Martin Herdegen (University of Warwick)

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.

The talk is based on joint work with Bruno Bouchard, Masaaki Fukasawa and Johannes Muhle-Karbe.

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