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BIRS Workshop Lecture Videos

Equilibrium models with small frictions Muhle-Karbe, Johannes


How does the introduction of a small trading friction such as a transaction tax affect financial markets? To answer questions of this kind, one needs to consider equilibrium models, where prices are determined endogenously. Indeed, taxes change agents' individual decision making, which in turn affects the market prices determined by their interactions. The new market environment then again alters the agents' behavior, leading to a notoriously intractable fixed point problem. In this talk we report on recent progress using asymptotic techniques for small trading frictions. In this practically relevant limiting regime, explicit solutions become available for the arising singular control problems, bringing analytical results for the equilibrium problem within reach. We also discuss how this allows to endogenize the trading friction, and study the arising link between liquidity and fundamental volatility. (Joint work with Martin Herdegen)

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