Solvable and frictionless markets
are populated by rational agents, which are then subjected to perturbations in an effort to recover economic realism.
Schaefer, 1984, "Continuous Price Processes in Frictionless Markets
Have Infinite Variation", Journal of Business, 57:353-365
There is much human agency in Rothenberg's "frictionless markets
" and the "rational calculations aimed at maximizing profits" of her subjects are as social as Bruegel's "relational considerations." After all, rational decisions in small-scale economic relations usually take place between or among socially alert participants.
If the deviations of the estimated conditional expectations function from constant expected returns are small (less than 0.1%, for example), then the assumption of frictionless markets may be economically acceptable.
Clearly, Equation 1 is a special case of Equation 4 corresponding to frictionless markets. This special case requires agents to react to all new information concerning future dividends, so that price always adjusts to the "fundamental" value given in Equation 5 below.
On the empirical level, a review of the literature reveals that the frictionless market assumption is not a realistic representation of how farmland is actually traded.
In this section, we first relate the theory of liquidity and asset pricing to the standard theory of asset pricing in frictionless markets. We then show how liquidity is priced in the most basic model of liquidity, where securities have exogenous trading costs and identical, risk-neutral investors have exogenous trading horizons (Section 2.2).
The assumption of frictionless markets is combined with one of the following three concepts: no arbitrage, agent optimality, and equilibrium.
In a frictionless market, the individual would be indifferent between a mortality swap and a bank deposit.
The article is organized as follows: the next section analyzes a mortality swap in a frictionless market. In "Markets With Personal Income Taxes," the authors introduce the Canadian personal income taxation into their model and identify the reasons for the existence of an arbitrage opportunity.