Viable Costs and Equilibrium Prices in Frictional Securities Markets

Zhiwu Chen

This paper studies security markets with trading frictions, and offers a complete characterization of viable convex cost systems. For frictional markets that give rise to a convex-cone traded-payoff span and a sublinear payoff cost functional, the following three conditions are equivalent: viability, the extension property, and the absence of free lunches. Special cases in this class of markets include perfect-markets economies [Harrison and Kreps (1979)], economies with proportional transaction costs [Jouini and Kallal (1992, 1995)], economies with solvency constraints [Hindy (1995)], economies with no-short-selling, and economies with any combination of these frictions.

Key Words: Frictional markets; Viable price system; No arbitrage; Free lunches; Sublinear price functional; Market frictions.
JEL Classification Numbers: G61, G10, G12, G20.