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Dynamic portfolio choice with frictions

Listed author(s):
  • Gârleanu, Nicolae
  • Pedersen, Lasse Heje

We show how portfolio choice can be modeled in continuous time with transitory and persistent transaction costs, multiple assets, multiple signals predicting returns, and general signal dynamics. The objective function is derived from the limit of discrete-time models with endogenous transaction costs due to optimal dealer behavior. We solve the model explicitly and the intuitive solution is also the limit of the solutions of the corresponding discrete-time models. We show how the optimal high-frequency trading strategy depends on the nature of the trading costs, which in turn depend on dealers' inventory dynamics. Finally, we provide equilibrium implications and illustrate the model's broader applicability to micro- and macro-economics, monetary policy, and political economy.

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File URL: http://www.sciencedirect.com/science/article/pii/S0022053116300382
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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 165 (2016)
Issue (Month): C ()
Pages: 487-516

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Handle: RePEc:eee:jetheo:v:165:y:2016:i:c:p:487-516
DOI: 10.1016/j.jet.2016.06.001
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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