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Equilibrium Asset Pricing with Transaction Costs

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  • Martin Herdegen
  • Johannes Muhle-Karbe
  • Dylan Possamai

Abstract

We study risk-sharing economies where heterogenous agents trade subject to quadratic transaction costs. The corresponding equilibrium asset prices and trading strategies are characterised by a system of nonlinear, fully-coupled forward-backward stochastic differential equations. We show that a unique solution generally exists provided that the agents' preferences are sufficiently similar. In a benchmark specification with linear state dynamics, the illiquidity discounts and liquidity premia observed empirically correspond to a positive relationship between transaction costs and volatility.

Suggested Citation

  • Martin Herdegen & Johannes Muhle-Karbe & Dylan Possamai, 2019. "Equilibrium Asset Pricing with Transaction Costs," Papers 1901.10989, arXiv.org, revised Sep 2020.
    • Handle: RePEc:arx:papers:1901.10989
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    References listed on IDEAS

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    Cited by:

    1. Johannes Muhle-Karbe & Marcel Nutz & Xiaowei Tan, 2019. "Asset Pricing with Heterogeneous Beliefs and Illiquidity," Papers 1905.05730, arXiv.org, revised Mar 2020.
    2. Moritz Vo{ss}, 2019. "A two-player portfolio tracking game," Papers 1911.05122, arXiv.org, revised Jul 2022.
    3. Guanxing Fu & Chao Zhou, 2021. "Mean Field Portfolio Games," Papers 2106.06185, arXiv.org, revised Apr 2022.
    4. Lukas Gonon & Johannes Muhle-Karbe & Xiaofei Shi, 2019. "Asset Pricing with General Transaction Costs: Theory and Numerics," Papers 1905.05027, arXiv.org, revised Apr 2020.
    5. Johannes Muhle-Karbe & Xiaofei Shi & Chen Yang, 2020. "An Equilibrium Model for the Cross-Section of Liquidity Premia," Papers 2011.13625, arXiv.org.

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