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Equilibrium price of immediacy and infrequent trade

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Author Info

  • Riccardo Giacomelli
  • Elisa Luciano

Abstract

The paper studies the equilibrium value of bid-ask spreads and time- to-trade in a continuous-time, intermediated fi?nancial market. The en- dogenous spreads are the price at which brokers are willing to offer imme- diacy. They include physical trading costs. Traders intervene optimally, when the portfolio mix reaches endogenously determined barriers. Spreads and times between successive trades are increasing with the difference in agents risk attitudes. They react asymmetrically to an increase in the difference of risk aversions, while they are symmetric in trading costs. We detect a bias towards cash. Optimal trade is drastically reduced when costs increase, so as to preserve the investors welfare. Random switches to a competitive market, to be interpreted as outside options, drastically reduce bid-ask fees.

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File URL: http://www.carloalberto.org/assets/working-papers/no.221.pdf
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Bibliographic Info

Paper provided by Collegio Carlo Alberto in its series Carlo Alberto Notebooks with number 221.

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Length: 36 pages
Date of creation: 2011
Date of revision: 2013
Handle: RePEc:cca:wpaper:221

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Related research

Keywords: equilibrium with dealers; equilibrium with bid-ask spreads; endogenous bid-ask; dynamic market making;

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References

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  1. Fernando Alvarez & Luigi Guiso & Francesco Lippi, 2012. "Durable Consumption and Asset Management with Transaction and Observation Costs," American Economic Review, American Economic Association, vol. 102(5), pages 2272-2300, August.
  2. Madhavan, A. & Smidt, S., 1991. "A Baysian Model of Intraday Specialist Pricing," Weiss Center Working Papers 2-91, Wharton School - Weiss Center for International Financial Research.
  3. Ho, Thomas & Stoll, Hans R., 1981. "Optimal dealer pricing under transactions and return uncertainty," Journal of Financial Economics, Elsevier, vol. 9(1), pages 47-73, March.
  4. Garman, Mark B., 1976. "Market microstructure," Journal of Financial Economics, Elsevier, vol. 3(3), pages 257-275, June.
  5. Dumas, Bernard & Luciano, Elisa, 1991. " An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs," Journal of Finance, American Finance Association, vol. 46(2), pages 577-95, June.
  6. Constantinides, George M, 1986. "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 842-62, August.
  7. Stefan Gerhold & Paolo Guasoni & Johannes Muhle-Karbe & Walter Schachermayer, 2011. "Transaction Costs, Trading Volume, and the Liquidity Premium," Papers 1108.1167, arXiv.org, revised Jan 2013.
  8. He, Hua & Leland, Hayne, 1993. "On Equilibrium Asset Price Processes," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 593-617.
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Cited by:
  1. Paolo Guasoni & Johannes Muhle-Karbe, 2011. "Long Horizons, High Risk Aversion, and Endogeneous Spreads," Papers 1110.1214, arXiv.org, revised Jul 2012.

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