Fairness in Trading — A Microeconomic Interpretation

We show that non-linear transaction costs generate external effects between accounts due to trade volume dependent marginal transaction costs.

Author(s):

Stephen Satchell

Professor of Finance, Birkbeck College & University of Cambridge

Bernhard Scherer

Professor of Finance, EDHEC Business School

For an asset manager with multiple clients this raises the question of fairness. How do I ensure I treat all clients fairly? In general, two possible solutions exist. The first is the so-called Cournot/Nash solution, where each account is optimized under the assumption that trading in the remaining accounts is given. However, in a Cournot/Nash equilibrium each client pays the average costs of trading but creates higher marginal costs (under the assumption of non-linear transaction costs) on the community of accounts. Ignoring this interdependence will hurt performance in all accounts. We model optimal trading with mean variance preferences as a duopoly game. This allows us to use well developed microeconomic tools for analysing the optimal trading problem and link it with the literature on external effects and their solution, i.e., the COASE theorem.

Type: Working paper
Date: le 19/11/2009
Research Cluster : Finance

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