The Value of Insider Information for Super--Replication with Quadratic Transaction Costs

TL;DR

This paper analyzes how insider information impacts super-replication costs in illiquid markets with quadratic transaction costs, providing a limit characterization as trading frequency increases.

Contribution

It introduces a scaling limit for super-replication prices in markets with insider information and quadratic costs, revealing the asymptotic value of insider advantage.

Findings

Derived the limit of super-replication prices as trading frequency grows

Quantified the value of insider information in illiquid markets

Established a connection between trading costs and insider advantage

Abstract

We study super--replication of European contingent claims in an illiquid market with insider information. Illiquidity is captured by quadratic transaction costs and insider information is modeled by an investor who can peek into the future. Our main result describes the scaling limit of the super--replication prices when the number of trading periods increases to infinity. Moreover, the scaling limit gives us the asymptotic value of being an insider.