Equilibrium Asset Pricing with Transaction Costs
32 Pages Posted: 11 Feb 2019 Last revised: 30 Sep 2020
Date Written: September 30, 2020
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: Suggested Citation