A model for a large investor trading at market indifference prices. I: Single-period case (Q2339125)

The authors study a market with transaction costs involving a sizable part of the market volume so that it is necessary to construct a model of their impact on the asset prices. A one-period and a continuous-time market are considered. Prices are quoted by some market makers, and the price impact is due to their risk aversion against growing inventories of risky securities. A specific feature is added that consists in the possibility of the market makers to hedge against the incurred risk by trading freely among themselves. This hedging opportunity leaves every market maker indifferent between the pre- and post-transaction allocation of wealth. The key tools in the study of market indifference prices are the convex duality theory for saddle functions and the classical parametrization of Pareto optimal allocations in terms of the aggregate utility function. The existence and uniqueness of market indifference prices is proved and their properties, including the computation of their sensitivities with respect to the order size, are studied.