An Equilibrium Model of Imperfect Hedging with Transaction Costs

Status	進行中Working
	An Equilibrium Model of Imperfect Hedging with Transaction Costs
	Loewentein, M.; Qin, Z.
Abstract	We study a model where two agents have linear exposures to non -traded risks and trade a zero net supply security. The zero net supply security has non-linear payoffs and is traded with proportional transaction costs. Equilibrium is described by the risk exposure and the risk premium of the derivative security. In our model, high risk exposure leads to smaller costs of setting up and unwinding the initial and terminal hedge positions but higher rebalancing costs. For any positive transaction cost there always exist no trade equilibria where risk exposure is so small that the position required to hedge would be large and the transaction costs outweigh any benefit of hedging or earning a risk premium. There are also equilibria with trade. When the agents have big differences in risk aversion, liquidity premia tend to be low, equilibrium risk exposure tends to be low, initial and terminal transaction costs tend to be high, and intermediate rebalancing costs tend to be low. When agents have similar risk aversion, liquidity premia tend to be high, equilibrium risk exposure tends to be high, the initial and terminal transaction costs tend to be low, and intermediate rebalancing costs tend to be high. We also study the expected trading profits for a market maker as a function of the level of transaction costs.
Keyword	Equilibrium Imperfect Hedging Transaction Costs Liquidity premium
Language	英語English
The Source to Article	PB_Publication
PUB ID	39564
Document Type	Report
Collection	University of Macau
Corresponding Author	Qin, Z.
Recommended Citation GB/T 7714	Loewentein, M.,Qin, Z.. An Equilibrium Model of Imperfect Hedging with Transaction Costs.

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