The impact of transaction costs on state-contingent claims mispricing

Valerio Restocchi, Frank McGroarty, Enrico Gerding, Johnnie E.V. Johnson

Research output: Contribution to journalArticlepeer-review

Abstract

We analyze the impact that transaction costs have on asset mispricing in state-contingent claims markets. In particular, we examine betting markets, in which, it has been argued, transaction costs cause the favorite-longshot bias, a pricing anomaly analogous to the volatility smile in options markets. By using a heterogeneous agents model, we prove that transaction costs alone cannot cause mispricing. Also, we run agent-based simulations to character- ize the response of market prices to increments in transaction costs. We find that transaction costs have a significant impact on market inefficiency, by amplifying existing mispricing both directly, influencing market prices, and indirectly, inducing a non-linear response from the agents.
Original languageEnglish
Pages (from-to)174 - 178
Number of pages5
JournalFinance Research Letters
Volume23
Early online date8 Feb 2017
DOIs
Publication statusE-pub ahead of print - 8 Feb 2017

Keywords

  • Transaction costs
  • Pricing anomalies
  • Heterogeneous agents
  • State-contingent claims
  • Favorite-longshot bias

Fingerprint

Dive into the research topics of 'The impact of transaction costs on state-contingent claims mispricing'. Together they form a unique fingerprint.

Cite this