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LONG HORIZONS, HIGH RISK AVERSION, AND ENDOGENOUS SPREADS
Author(s) -
Guasoni Paolo,
MuhleKarbe Johannes
Publication year - 2015
Publication title -
mathematical finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.98
H-Index - 81
eISSN - 1467-9965
pISSN - 0960-1627
DOI - 10.1111/mafi.12046
Subject(s) - economics , risk aversion (psychology) , monopolistic competition , stackelberg competition , transaction cost , econometrics , investment (military) , market liquidity , microeconomics , constant (computer programming) , financial economics , monetary economics , expected utility hypothesis , monopoly , politics , political science , law , programming language , computer science
For an investor with constant absolute risk aversion and a long horizon, who trades in a market with constant investment opportunities and small proportional transaction costs, we obtain explicitly the optimal investment policy, its implied welfare, liquidity premium, and trading volume. We identify these quantities as the limits of their isoelastic counterparts for high levels of risk aversion. The results are robust with respect to finite horizons, and extend to multiple uncorrelated risky assets. In this setting, we study a Stackelberg equilibrium, led by a risk‐neutral, monopolistic market maker who sets the spread as to maximize profits. The resulting endogenous spread depends on investment opportunities only, and is of the order of a few percentage points for realistic parameter values.