Equilibrium Asset Pricing with Transaction Costs

32 Pages Posted: 11 Feb 2019 Last revised: 30 Sep 2020

See all articles by Martin Herdegen

Martin Herdegen

University of Warwick - Department of Statistics

Johannes Muhle-Karbe

Imperial College London - Department of Mathematics

Dylan Possamaï

Columbia University

Date Written: September 30, 2020

Abstract

We study risk-sharing economies where heterogenous agents trade subject to quadratic transaction costs. The corresponding equilibrium asset prices and trading strategies are characterised by a system of nonlinear, fully-coupled forward-backward stochastic differential equations. We show that a unique solution generally exists provided that the agents' preferences are sufficiently similar. In a benchmark specification with linear state dynamics, the illiquidity discounts and liquidity premia observed empirically correspond to a positive relationship between transaction costs and volatility.

Keywords: Asset Pricing, Radner Equilibrium, Transaction Costs, Forward-Backward SDEs

JEL Classification: C68, D52, G11, G12

Suggested Citation

Herdegen, Martin and Muhle-Karbe, Johannes and Possamaï, Dylan, Equilibrium Asset Pricing with Transaction Costs (September 30, 2020). Available at SSRN: https://ssrn.com/abstract=3326085 or http://dx.doi.org/10.2139/ssrn.3326085

Martin Herdegen

University of Warwick - Department of Statistics ( email )

Coventry CV4 7AL
United Kingdom

Johannes Muhle-Karbe (Contact Author)

Imperial College London - Department of Mathematics ( email )

South Kensington Campus
Imperial College
LONDON, SW7 2AZ
United Kingdom

Dylan Possamaï

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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