TY - JOUR

T1 - Portfolio optimization with transaction costs : a two-period mean-variance model

AU - Fu, Ying Hui

AU - Ng, Kien Ming

AU - Huang, B.

AU - Huang, Huei Chuen

PY - 2015/10

Y1 - 2015/10

N2 - In this paper, we study a multiperiod mean-variance portfolio optimization problem in the presence of proportional transaction costs. Many existing studies have shown that transaction costs can significantly affect investors’ behavior. However, even under simple assumptions, closed-form solutions are not easy to obtain when transaction costs are considered. As a result, they are often ignored in multiperiod portfolio analysis, which leads to suboptimal solutions. To provide better insight for this complex problem, this paper studies a two-period problem that considers one risk-free and one risky asset. Whenever there is a trade after the initial asset allocation, the investor incurs a linear transaction cost. Through a mean-variance model, we derive the closed-form expressions of the optimal thresholds for investors to re-allocate their resources. These thresholds divide the action space into three regions. Some important properties of the analytical solution are identified, which shed light on solving multiperiod problems.

AB - In this paper, we study a multiperiod mean-variance portfolio optimization problem in the presence of proportional transaction costs. Many existing studies have shown that transaction costs can significantly affect investors’ behavior. However, even under simple assumptions, closed-form solutions are not easy to obtain when transaction costs are considered. As a result, they are often ignored in multiperiod portfolio analysis, which leads to suboptimal solutions. To provide better insight for this complex problem, this paper studies a two-period problem that considers one risk-free and one risky asset. Whenever there is a trade after the initial asset allocation, the investor incurs a linear transaction cost. Through a mean-variance model, we derive the closed-form expressions of the optimal thresholds for investors to re-allocate their resources. These thresholds divide the action space into three regions. Some important properties of the analytical solution are identified, which shed light on solving multiperiod problems.

KW - Investment analysis

KW - Multiperiod portfolio optimization

KW - Mean-variance analysis

KW - Transaction costs

U2 - 10.1007/s10479-014-1574-x

DO - 10.1007/s10479-014-1574-x

M3 - Article

VL - 233

SP - 135

EP - 156

JO - Annals of Operations Research

JF - Annals of Operations Research

SN - 0254-5330

IS - 1

ER -