Mean Reversion Pays, but Costs
AbstractA mean-reverting financial instrument is optimally traded by buying it when it is sufficiently below the estimated `mean level' and selling it when it is above. In the presence of linear transaction costs, a large amount of value is paid away crossing bid-offers unless one devises a `buffer' through which the price must move before a trade is done. In this paper, Richard Martin and Torsten Sch\"oneborn derive the optimal strategy and conclude that for low costs the buffer width is proportional to the cube root of the transaction cost, determining the proportionality constant explicitly.
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Bibliographic InfoPaper provided by arXiv.org in its series Papers with number 1103.4934.
Date of creation: Mar 2011
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Web page: http://arxiv.org/
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-02 (All new papers)
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- L.C.G. Rogers, 2001. "The relaxed investor and parameter uncertainty," Finance and Stochastics, Springer, vol. 5(2), pages 131-154.
- Richard J. Martin, 2012. "Optimal multifactor trading under proportional transaction costs," Papers 1204.6488, arXiv.org.
- Jan Kallsen & Johannes Muhle-Karbe, 2013. "The General Structure of Optimal Investment and Consumption with Small Transaction Costs," Papers 1303.3148, arXiv.org.
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