Efficient trading strategies in the presence of market frictions

We provide a price characterization of efficient contingentclaims - that is, chosen by at least a rational agent - in multiperiodeconomies with market frictions. Frictions include market incompleteness,transaction costs, short-selling, and borrowing costs. We characterizethe inefficiency cost of a trading strategy - its required investmentminus the largest amount necessary to obtain the same utilitylevel - and we propose a measure of portfolio performance. Weshow that arbitrage bounds cannot be tightened based on efficiencywithout restricting preferences or endowments. We observe commoninvestment strategies becoming inefficient with market frictionsand others rationalized by them.