Portfolio Choice in an Incomplete Market with Frictions

Posted: 23 Aug 2010 Last revised: 10 Nov 2011

See all articles by Thomas Leirvik

Thomas Leirvik

University of Lugano - Institute of Finance

Date Written: August 23, 2010

Abstract

A novel method to analyze the impact of transaction costs on a dynamically optimized portfolio is developed. Transaction costs, when taken into account in an incomplete market, generate a liquidity premium which is large enough to address important economic questions, such as the size of the equity risk premium. The sensitivity of the investor to deviations from the optimal portfolio allocation with respect to risk aversion, increases in risk aversion. This contrasts results in traditional literature, which find it to be constant, and is due to the impact of transaction costs.

Keywords: Transaction costs, Portfolio choice, incomplete market, liquidity premium, equity premium

JEL Classification: C02, G11

Suggested Citation

Leirvik, Thomas, Portfolio Choice in an Incomplete Market with Frictions (August 23, 2010). 23rd Australasian Finance and Banking Conference 2010 Paper. Available at SSRN: https://ssrn.com/abstract=1663992

Thomas Leirvik (Contact Author)

University of Lugano - Institute of Finance ( email )

Via Buffi 13
CH-6900 Lugano
Switzerland
+1 2039887643 (Phone)

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