MathTalksAustria

Abstract: Constantinides (1986) observed that "transaction costs have a first order effect on asset demand". On the other hand, he found that their welfare impact is typically small, since "a small liquidity premium is sufficient to compensate an investor from deviating significantly from the target portfolio proportions". Starting from the work of Shreve and Soner (1994), these numerical results have been made precise in an asymptotic sense: deviations from the optimal frictionless portfolio are of order $\varepsilon^{1/3}$ as the spread $\epsilon$ becomes small, but the corresponding liquidity premium and utility loss are only of order $\varepsilon^{2/3}$. In the present study, we discuss how these results change if exogenous portfolio constraints limit the investor’s position in the risky asset. This is joint work with Ren Liu.