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Efficient Trading Strategies in the Presence of Market Frictions


  • Elyès Jouini


  • Hédi Kallal



In this paper we provide a price characterization of efficient consumption bundles in multiperiod economies with market frictions. Efficient consumption bundles are those that are chosen by at least one rational agent with monotonic state-independent and risk-averse preferences and a given future endowment. Frictions include dynamic market incompleteness, proportional transaction costs, short selling costs, borrowing costs, taxes, and others. We characterize the inefficiency cost of a trading strategy -the difference between the investment it requires and the largest amount required by any rational agent to obtain the same utility level - and we propose a measure of portfolio performance based on it. We also show that the arbitrage bounds on a contingent claim to consumption cannot be tightened based on efficiency arguments without restricting preferences or endowments. We examine the efficiency of common investment strategies in economies with borrowing costs due to asymmetric information, short selling costs, or bid-ask spreads. We find that market frictions generally change and typically shrink the set of efficient investment strategies, shifting investors away from well-diversified strategies into low cost ones, and for large frictions into no trading at all. Hence we observe strategies that become inefficient with market frictions, as well as strategies that are rationalized by market frictions.
(This abstract was borrowed from another version of this item.)

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  • Elyès Jouini & Hédi Kallal, 1998. "Efficient Trading Strategies in the Presence of Market Frictions," Working Papers 98-31, Center for Research in Economics and Statistics.
  • Handle: RePEc:crs:wpaper:98-31

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    References listed on IDEAS

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    Cited by:

    1. Kuersten, Wolfgang & Linde, Rainer, 2011. "Corporate hedging versus risk-shifting in financially constrained firms: The time-horizon matters!," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 502-525, June.
    2. Au, Andrea S. & Doukas, John A. & Onayev, Zhan, 2009. "Daily short interest, idiosyncratic risk, and stock returns," Journal of Financial Markets, Elsevier, vol. 12(2), pages 290-316, May.
    3. De Giorgi, Enrico, 2005. "Reward-risk portfolio selection and stochastic dominance," Journal of Banking & Finance, Elsevier, vol. 29(4), pages 895-926, April.
    4. Rüschendorf Ludger & Wolf Viktor, 2015. "Cost-efficiency in multivariate Lévy models," Dependence Modeling, De Gruyter Open, vol. 3(1), pages 1-16, April.
    5. Grigorova Miryana, 2014. "Stochastic orderings with respect to a capacity and an application to a financial optimization problem," Statistics & Risk Modeling, De Gruyter, vol. 31(2), pages 1-31, June.
    6. Marc Rieger, 2011. "Co-monotonicity of optimal investments and the design of structured financial products," Finance and Stochastics, Springer, vol. 15(1), pages 27-55, January.
    7. Aloisio Araujo & Alain Chateauneuf & José Faro, 2012. "Pricing rules and Arrow–Debreu ambiguous valuation," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 49(1), pages 1-35, January.
    8. Bruno Bouchard & Elyès Jouini, 2010. "Transaction Costs in Financial Models," Post-Print halshs-00703138, HAL.
    9. Balbás, Alejandro & Downarowicz, Anna, 2004. "Infinitely many securities and the fundamental theorem of asset pricing," DEE - Working Papers. Business Economics. WB wb043513, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    10. repec:eee:jetheo:v:173:y:2018:i:c:p:257-288 is not listed on IDEAS
    11. Beare, Brendan K., 2011. "Measure preserving derivatives and the pricing kernel puzzle," Journal of Mathematical Economics, Elsevier, vol. 47(6), pages 689-697.
    12. Bizid, Abdelhamid & Jouini, Elyès, 2005. "Equilibrium Pricing in Incomplete Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(04), pages 833-848, December.
    13. Borglin, Anders & Flåm, Sjur, 2007. "Rationalizing Constrained Contingent Claims," Working Papers 2007:12, Lund University, Department of Economics.
    14. Janchung Wang, 2010. "Short Selling and Index Arbitrage Profitability: Evidence from the SGX MSCI and TAIFEX Taiwan Index Futures Markets," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 46(5), pages 48-66, September.
    15. Janchung Wang, 2010. "Short Selling and Index Arbitrage Profitability: Evidence from the SGX MSCI and TAIFEX Taiwan Index Futures Markets," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 46(5), pages 48-66, September.
    16. Baccara, Mariagiovanna & Battauz, Anna & Ortu, Fulvio, 2006. "Effective securities in arbitrage-free markets with bid-ask spreads at liquidation: a linear programming characterization," Journal of Economic Dynamics and Control, Elsevier, vol. 30(1), pages 55-79, January.

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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets


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