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- Title
Liquidity risk and arbitrage pricing theory.
- Authors
Çtin, Umut; Jarrow, Robert A.; Protter, Philip
- Abstract
Classical theories of financial markets assume an infinitely liquid market and that all traders act as price takers. This theory is a good approximation for highly liquid stocks, although even there it does not apply well for large traders or for modelling transaction costs. We extend the classical approach by formulating a new model that takes into account illiquidities. Our approach hypothesizes a stochastic supply curve for a security’s price as a function of trade size. This leads to a new definition of a self-financing trading strategy, additional restrictions on hedging strategies, and some interesting mathematical issues.
- Subjects
STOCKS (Finance); FINANCIAL markets; FLOOR traders (Finance); TRANSACTION costs; PRICES of securities; STOCHASTIC integrals
- Publication
Finance & Stochastics, 2004, Vol 8, Issue 3, p311
- ISSN
0949-2984
- Publication type
Article
- DOI
10.1007/s00780-004-0123-x