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Rev Fin 2001; 14:343-369
© 2001 the Society for Financial Studies

Article

Efficient trading strategies in the presence of market frictions

E Jouini1,z and H Kallal2
1 CREST, timbre J320, 15, Boulevard Gabriel Peri, 92 245 Malakoff-Cedex, France
2 Citadel Investment Group
z Corresponding author
E-mail: jouini@ensae.fr

Abstract

We provide a price characterization of efficient contingent claims - that is, chosen by at least a rational agent - in multiperiod economies with market frictions. Frictions include market incompleteness, transaction costs, short-selling, and borrowing costs. We characterize the inefficiency cost of a trading strategy - its required investment minus the largest amount necessary to obtain the same utility level - and we propose a measure of portfolio performance. We show that arbitrage bounds cannot be tightened based on efficiency without restricting preferences or endowments. We observe common investment strategies becoming inefficient with market frictions and others rationalized by them.


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