Staff Report 128

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Duality and Arbitrage With Transactions Costs: Theory and Applications

Michael J. Stutzer - Professor of Finance, University of Iowa

Published November 1, 1989

Abstract
Recent advances in duality theory have made it easier to discover relationships between asset prices and the portfolio choices based on them. But this approach to arbitrage-free securities markets has yet to be extended and applied to economies with transactions costs. This paper does so, within the context of a general state-preference model of securities markets. Several applications are developed to illustrate the nature of the theory and its potential to resolve a host of issues surrounding the effects of transactions costs on securities markets.

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