Hysteresis Bands, Holding Period and Transaction Costs

54 Pages Posted: 30 Jun 2012

See all articles by Bernard Dumas

Bernard Dumas

INSEAD; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Giovanni Walter Puopolo

University of Naples Federico II - Department of Economic and Statistical Sciences

Francisco Delgado

UBS AG - Warburg

Date Written: June 30, 2012

Abstract

In the presence of transactions costs, no matter how small, arbitrage activity does not necessarily render equal all riskless rates of return. When two such rates follow stochastic processes, it is not optimal immediately to arbitrage out any discrepancy that arises between them. The reason is that immediate arbitrage would induce a de…finite expenditure of transactions costs whereas, without arbitrage intervention, there exists some, perhaps sufficient, probability that these two interest rates will come back together without any costs having been incurred. Hence, one can surmise that at equilibrium the …financial market will permit the coexistence of two riskless rates that are not equal to each other. For analogous reasons, randomly fl‡uctuating expected rates of return on risky assets will be allowed to differ even after correction for risk, leading to important violations of the Capital Asset Pricing Model. The combination of randomness in expected rates of return and proportional transactions costs is a serious blow to existing frictionless pricing models.

Suggested Citation

Dumas, Bernard and Puopolo, Giovanni Walter and Delgado, Francisco, Hysteresis Bands, Holding Period and Transaction Costs (June 30, 2012). Available at SSRN: https://ssrn.com/abstract=2096871 or http://dx.doi.org/10.2139/ssrn.2096871

Bernard Dumas

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National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Centre for Economic Policy Research (CEPR)

London
United Kingdom

Giovanni Walter Puopolo (Contact Author)

University of Naples Federico II - Department of Economic and Statistical Sciences ( email )

Via Cintia 26
Napoli
Italy

Francisco Delgado

UBS AG - Warburg ( email )

677 Washington Blvd.
Stamford, CT 06901
United States

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