Long Horizons, High Risk Aversion, and EndogeneousSpreads

For an investor with constant absolute risk aversion and a long horizon, who trades in amarket with constant investment opportunities and small proportional transaction costs, weobtain explicitly the optimal investment policy, its implied welfare, liquidity premium, andtrading volume. We identify these quantities as the limits of their isoelastic counterparts forhigh levels of risk aversion. The results are robust with respect to finite horizons, and extendto multiple uncorrelated risky assets.In this setting, we study a Stackelberg equilibrium, led by a risk-neutral, monopolistic marketmaker who sets the spread as to maximize profits. The resulting endogenous spread dependson investment opportunities only, and is of the order of a few percentage points for realisticparameter values.[...]