Transaction Costs in a Model of Capital Market Equilibrium

This paper analyzes a simple mean-variance model of an imperfect capital market in which trade in assets involves costs. Fixed transactions costs, which result in investors only partially diversifying their portfolios, are shown to imply equilibrium asset prices substantially different from the Sharpe-Lintner prices. An improvement in the markets, in the form of lowering the trading costs, is shown to result in an increase in the number of assets held by each investor, in lowering equilibrium risk premia, and also in increasing the number of active investors.