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http://hdl.handle.net/2451/26972
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| Title: | Efficient Trading Strategies in the Presence of Market Frictions |
| Authors: | Jouini, Elyès
Kallal, Hédi |
| Issue Date: | Sep-1999 |
| Series/Report no.: | FIN-99-035 |
| Abstract: | 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. |
| URI: | http://hdl.handle.net/2451/26972 |
| Appears in Collections: | Finance Working Papers
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