Bid-ask dynamic pricing in financial markets with transaction costs and liquidity risk

DOI10.1016/J.JMATECO.2009.05.004zbMATH Open1179.91084arXivmath/0703074OpenAlexW1983298220MaRDI QIDQ1045982FDOQ1045982

Authors: Jocelyne Bion-Nadal 

Publication date: 21 December 2009

Published in: Journal of Mathematical Economics (Search for Journal in Brave)

Abstract: We introduce, in continuous time, an axiomatic approach to assign to any financial position a dynamic ask (resp. bid) price process. Taking into account both transaction costs and liquidity risk this leads to the convexity (resp. concavity) of the ask (resp. bid) price. Time consistency is a crucial property for dynamic pricing. Generalizing the result of Jouini and Kallal, we prove that the No Free Lunch condition for a time consistent dynamic pricing procedure (TCPP) is equivalent to the existence of an equivalent probability measure $R$ that transforms a process between the bid process and the ask process of any financial instrument into a martingale. Furthermore we prove that the ask price process associated with any financial instrument is then a $R$-supermartingale process which has a cadlag modification. Finally we show that time consistent dynamic pricing allows both to extend the dynamics of some reference assets and to be consistent with any observed bid ask spreads that one wants to take into account. It then provides new bounds reducing the bid ask spreads for the other financial instruments.

Full work available at URL: https://arxiv.org/abs/math/0703074

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zbMATH Keywords

transaction costsliquidity riskdynamic risk measuresbid ask spreadsdynamic price processno-arbitrage assumption

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Martingales with continuous parameter (60G44) Microeconomic theory (price theory and economic markets) (91B24)

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Cited In (28)

• Utility maximization in markets with bid-ask spreads
• CONIC TRADING IN A MARKOVIAN STEADY STATE
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• On the calibration of distortion risk measures to bid-ask prices
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