Dynamic Portfolio Optimization with Transaction Costs and State-Dependent Drift

TY - JOUR

T1 - Dynamic Portfolio Optimization with Transaction Costs and State-Dependent Drift

AU - Palczewski, Jan

AU - Poulsen, Rolf

AU - Schenk-Hoppe, Klaus Reiner

AU - Wang, Huamao

PY - 2015/6/16

Y1 - 2015/6/16

N2 - The problem of dynamic portfolio choice with transaction costs is often addressed by constructing a Markov Chain approximation of the continuous time price processes. Using this approximation, we present an efficient numerical method to determine optimal portfolio strategies under time- and state-dependent drift and proportional transaction costs. This scenario arises when investors have behavioral biases or the actual drift is unknown and needs to be estimated. Our numerical method solves dynamic optimal portfolio problems with an exponential utility function for time-horizons of up to 40 years. It is applied to measure the value of information and the loss from transaction costs using the indifference principle.

AB - The problem of dynamic portfolio choice with transaction costs is often addressed by constructing a Markov Chain approximation of the continuous time price processes. Using this approximation, we present an efficient numerical method to determine optimal portfolio strategies under time- and state-dependent drift and proportional transaction costs. This scenario arises when investors have behavioral biases or the actual drift is unknown and needs to be estimated. Our numerical method solves dynamic optimal portfolio problems with an exponential utility function for time-horizons of up to 40 years. It is applied to measure the value of information and the loss from transaction costs using the indifference principle.

U2 - 10.1016/j.ejor.2014.12.040

DO - 10.1016/j.ejor.2014.12.040

M3 - Journal article

SN - 0377-2217

VL - 243

SP - 921

EP - 931

JO - European Journal of Operational Research

JF - European Journal of Operational Research

IS - 3

ER -