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Modeling Liquidity Effects In Discrete Time

Author

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  • Umut Çetin
  • L. C. G. Rogers

Abstract

We study optimal portfolio choices for an agent with the aim of maximizing utility from terminal wealth within a market with liquidity costs. Under some mild conditions, we show the existence of optimal portfolios and that the marginal utility of the optimal terminal wealth serves as a change of measure to turn the marginal price process of the optimal strategy into a martingale. Finally, we illustrate our results numerically in a Cox–Ross–Rubinstein binomial model with liquidity costs and find the reservation ask prices for simple European put options.

Suggested Citation

  • Umut Çetin & L. C. G. Rogers, 2007. "Modeling Liquidity Effects In Discrete Time," Mathematical Finance, Wiley Blackwell, vol. 17(1), pages 15-29, January.
    • Handle: RePEc:bla:mathfi:v:17:y:2007:i:1:p:15-29
    DOI: 10.1111/j.1467-9965.2007.00292.x
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    JEL classification:

    • F3 - International Economics - - International Finance
    • G3 - Financial Economics - - Corporate Finance and Governance

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