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The impact of transaction costs on state-contingent claims mispricing

Restocchi, Valerio, Mcgroarty, Frank, Gerding, Enrico and Johnson, Johnnie (2017) The impact of transaction costs on state-contingent claims mispricing Finance Research Letters (doi:10.1016/j.frl.2017.02.006).

Record type: Article

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 characterize 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

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More information

Accepted/In Press date: 3 February 2017
e-pub ahead of print date: 8 February 2017
Keywords: favorite-longshot bias, heterogeneous agents, pricing anomalies, state-contingent claims, transaction costs
Organisations: Southampton Business School

Identifiers

Local EPrints ID: 405512
URI: http://eprints.soton.ac.uk/id/eprint/405512
ISSN: 1544-6123
PURE UUID: c074abb1-0bf2-4d31-a4ad-e1fc7cb13015

Catalogue record

Date deposited: 06 Feb 2017 14:05
Last modified: 18 Aug 2017 16:32

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