# Equilibrium Asset Pricing with Transaction Costs

## TL;DR

This paper models equilibrium asset prices in markets with transaction costs, showing how costs influence liquidity premiums and volatility through a system of complex stochastic equations.

## Contribution

It introduces a novel equilibrium framework incorporating quadratic transaction costs and characterizes asset prices via coupled stochastic differential equations.

## Key findings

- Illiquidity discounts increase with transaction costs.
- Liquidity premia are positively related to volatility.
- Unique solutions exist when agents' preferences are similar.

## Abstract

We study risk-sharing economies where heterogenous agents trade subject to quadratic transaction costs. The corresponding equilibrium asset prices and trading strategies are characterised by a system of nonlinear, fully-coupled forward-backward stochastic differential equations. We show that a unique solution generally exists provided that the agents' preferences are sufficiently similar. In a benchmark specification with linear state dynamics, the illiquidity discounts and liquidity premia observed empirically correspond to a positive relationship between transaction costs and volatility.