Good deals in markets with frictions
AbstractThis paper studies a portfolio choice problem such that the pricing rule may incorporate transaction costs and the risk measure is coherent and expectation bounded. We will prove the necessity of dealing with pricing rules such that there are essentially bounded stochastic discount factors, which must be also bounded from below by a strictly positive value. Otherwise good deals will be available to traders, i.e., depending on the selected risk measure, investors can build portfolios whose (risk, return) will be as close as desired to (- infinite, + infinite) or (0, infinite). This pathologic property still holds for vector risk measures (i.e., if we minimize a vector valued function whose components are risk measures). It is worthwhile to point out that essentially bounded stochastic discount factors are not usual in financial literature. In particular, the most famous frictionless, complete and arbitrage free pricing models imply the existence of good deals for every coherent and expectation bounded measure of risk, and the incorporation of transaction costs will no guarantee the solution of this caveat
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Bibliographic InfoPaper provided by Universidad Carlos III, Departamento de Economía de la Empresa in its series Business Economics Working Papers with number wb110302.
Date of creation: Feb 2011
Date of revision:
Risk measure; Perfect and imperfect markets; Stochastic discount factor; Portfolio choice model; Good deal;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
This paper has been announced in the following NEP Reports:
- NEP-AGR-2011-03-12 (Agricultural Economics)
- NEP-ALL-2011-03-12 (All new papers)
- NEP-RMG-2011-03-12 (Risk Management)
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