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Modeling liquidity effects in discrete time

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We study optimal portfolio choices for an agent with the aim of maximising utility from terminal wealth within a market with liquidity costs. Under some mild conditions, we show the existence of optimal portfolios and that the marginal utility of the optimal terminal wealth serves as a change of measure to turn the marginal price process of the optimal strategy into a martingale. Finally, we illustrate our results numerically in a Cox-Ross-Rubinstein binomial model with liquidity costs and find the reservation ask prices for simple European put options.

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en

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application/pdf

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http://eprints.lse.ac.uk/2844/1/Modelling_liquidity_effects_%28LSERO_version%29.pdf

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