Stability of Radner Equilibria with Respect to Small Frictions

Abstract

We study risk-sharing equilibria with trading subject to small proportional transaction costs. We show that the frictionless equilibrium prices also form an "asymptotic equilibrium" in the small-cost limit. To wit, there exist asymptotically optimal policies for all agents and a split of the trading cost according to their risk aversions for which the frictionless equilibrium prices still clear the market. Starting from a frictionless equilibrium, this allows to study the interplay of volatility, liquidity, and trading volume.

Keywords: Trading costs, Radner equilibrium, asymptotics, stability, transaction tax

JEL Classification: D52, G11, G12