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Efficient Trading Strategies in the Presence of Market Frictions

  • Elyès Jouini

    (Crest)

  • Hédi Kallal

    (Crest)

We provide a price characterization of efficient contingent claims--that is, chosen by at least a rational agent--in multiperiod economies with market frictions. Frictions include market incompleteness, transaction costs, short-selling, and borrowing costs. We characterize the inefficiency cost of a trading strategy--its required investment minus the largest amount necessary to obtain the same utility level--and we propose a measure of portfolio performance. We show that arbitrage bounds cannot be tightened based on efficiency without restricting preferences or endowments. We observe common investment strategies becoming inefficient with market frictions and others rationalized by them. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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Paper provided by Centre de Recherche en Economie et Statistique in its series Working Papers with number 98-31.

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Date of creation: 1998
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Handle: RePEc:crs:wpaper:98-31
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  1. Pelsser, Antoon & Vorst, Ton, 1996. "Transaction costs and efficiency of portfolio strategies," European Journal of Operational Research, Elsevier, vol. 91(2), pages 250-263, June.
  2. Philip H. Dybvig, 1987. "Distributional Analysis of Portfolio Choice," Cowles Foundation Discussion Papers 827R, Cowles Foundation for Research in Economics, Yale University, revised Jan 1988.
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  4. Tuckman, Bruce & Vila, Jean-Luc, 1992. " Arbitrage with Holding Costs: A Utility-Based Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1283-302, September.
  5. Elyès Jouini & Hédi Kallal, 1999. "Viability and Equilibrium in Securities Markets with Frictions," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-036, New York University, Leonard N. Stern School of Business-.
  6. Elyégs Jouini & Hédi Kallal, 1995. "Arbitrage In Securities Markets With Short-Sales Constraints," Mathematical Finance, Wiley Blackwell, vol. 5(3), pages 197-232.
  7. Ross, Stephen A, 1987. "Arbitrage and Martingales with Taxation," Journal of Political Economy, University of Chicago Press, vol. 95(2), pages 371-93, April.
  8. He Hua & Huang Chi-fu, 1994. "Consumption-Portfolio Policies: An Inverse Optimal Problem," Journal of Economic Theory, Elsevier, vol. 62(2), pages 257-293, April.
  9. Jouini Elyes & Kallal Hedi, 1995. "Martingales and Arbitrage in Securities Markets with Transaction Costs," Journal of Economic Theory, Elsevier, vol. 66(1), pages 178-197, June.
  10. Hua He & Neil D. Pearson, 1991. "Consumption and Portfolio Policies With Incomplete Markets and Short-Sale Constraints: the Finite-Dimensional Case," Mathematical Finance, Wiley Blackwell, vol. 1(3), pages 1-10.
  11. Constantinides, George M, 1986. "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 842-62, August.
  12. Peleg, Bezalel, 1975. "Efficient random variables," Journal of Mathematical Economics, Elsevier, vol. 2(2), pages 243-252.
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  14. Figlewski, Stephen, 1989. " Options Arbitrage in Imperfect Markets," Journal of Finance, American Finance Association, vol. 44(5), pages 1289-1311, December.
  15. Dybvig, Philip H & Ross, Stephen A, 1986. " Tax Clienteles and Asset Pricing," Journal of Finance, American Finance Association, vol. 41(3), pages 751-62, July.
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  19. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June.
  20. Blume, Lawrence & Brandenburger, Adam & Dekel, Eddie, 1991. "Lexicographic Probabilities and Equilibrium Refinements," Econometrica, Econometric Society, vol. 59(1), pages 81-98, January.
  21. Dybvig, Philip H & Ross, Stephen A, 1982. "Portfolio Efficient Sets," Econometrica, Econometric Society, vol. 50(6), pages 1525-46, November.
  22. Lawrence Blume & Adam Brandenburger & Eddie Dekel, 2014. "Lexicographic Probabilities and Choice Under Uncertainty," World Scientific Book Chapters, in: The Language of Game Theory Putting Epistemics into the Mathematics of Games, chapter 6, pages 137-160 World Scientific Publishing Co. Pte. Ltd..
  23. Philip H. Dybvig, 1987. "Inefficient Dynamic Portfolio Strategies or How to Throw Away a Million Dollars in the Stock Market," Cowles Foundation Discussion Papers 826R, Cowles Foundation for Research in Economics, Yale University, revised Jan 1988.
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  26. Peleg, Bezalel & Yaari, M E, 1975. "A Price Characterization of Efficient Random Variables," Econometrica, Econometric Society, vol. 43(2), pages 283-92, March.
  27. Dumas, Bernard & Luciano, Elisa, 1991. " An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs," Journal of Finance, American Finance Association, vol. 46(2), pages 577-95, June.
  28. Bernard Bensaid & Jean-Philippe Lesne & Henri Pagès & José Scheinkman, 1992. "Derivative Asset Pricing With Transaction Costs," Mathematical Finance, Wiley Blackwell, vol. 2(2), pages 63-86.
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