Equilibrium asset pricing with transaction costs

Abstract We study risk-sharing economies where heterogeneous 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. show that unique solution exists provided the agents’ preferences sufficiently similar. In benchmark specification with linear state dynamics, empirically observed illiquidity discounts liquidity premia correspond positive relationship between costs volatility.