Solvency Cone

DEFINITION of 'Solvency Cone'

A model that considers the impact of transaction costs while trading financial assets. The solvency cone at a certain time ("t") is the set of those positions that can be exchanged into a non-negative portfolio at time t after taking bid-ask prices into consideration. The spread between bid and ask prices is a very significant component of transaction costs.

BREAKING DOWN 'Solvency Cone'

Classical financial models generally do not take transaction costs into account, which hampers their application in the real world, since these costs are a significant factor in trading decisions. The solvency cone eliminates this drawback by taking transaction costs into account in its model. The concept finds a great deal of application in markets such as foreign exchange. While bid-ask spreads can be quite narrow in the foreign exchange market, the large position sizes in the interbank and institutional segments of the forex market can result in significant transaction costs.

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RELATED FAQS
  1. Are solvency ratios more concerned with the short-term or the long-term?

    Learn what solvency is, how to use ratios to determine a company's solvency, and why solvency ratios are concerned with the ... Read Answer >>
  2. What's the difference between bid-ask spread and bid-ask bounce?

    Understand the difference between the bid-ask spread that determines the buy or sell price for a stock and a bid-ask bounce, ... Read Answer >>
  3. How do unfunded capital expenditures and distributions affect the fixed charge coverage ...

    Learn about the most common solvency ratio and what it measures. Understand two other liquidity ratios that are commonly ... Read Answer >>
  4. What are the determinants of a stock's bid-ask spread?

    Stock exchanges are set up to assist brokers and other specialists in coordinating bid and ask prices. The bid price is the ... Read Answer >>
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