Transaction Costs, Trading Volume, and the Liquidity Premium
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Fri, 03/02/2012 14:15 |
Stefan Gerold (TU Wien) |
Nomura Seminar  |
DH 1st floor SR |
| In a market with one safe and one risky asset, an investor with a long horizon and constant relative risk aversion trades with constant investment opportunities and proportional transaction costs. We derive the optimal investment policy, its welfare, and the resulting trading volume, explicitly as functions of the market and preference parameters, and of the implied liquidity premium, which is identified as the solution of a scalar equation. For small transaction costs, all these quantities admit asymptotic expansions of arbitrary order. The results exploit the equivalence of the transaction cost market to another frictionless market, with a shadow risky asset, in which investment opportunities are stochastic. The shadow price is also derived explicitly. (Joint work with Paolo Guasoni, Johannes Muhle-Karbe, and Walter Schachermayer) | |||