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

Ying Hui Fu, Kien Ming Ng, Boray Huang (Lead / Corresponding author), Huei Chuen Huang

Research output: Contribution to journalArticlepeer-review

4 Citations (Scopus)

Abstract

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.

Original languageEnglish
Pages (from-to)135-156
Number of pages22
JournalAnnals of Operations Research
Volume233
Issue number1
Early online date21 Jun 2014
DOIs
Publication statusPublished - Oct 2015

Keywords

  • Investment analysis
  • Mean-variance analysis
  • Multiperiod portfolio optimization
  • Transaction costs

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