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Mean Reversion Pays, but Costs

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  • Richard Martin
  • Torsten Sch\"oneborn
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    Abstract

    A 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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    File URL: http://arxiv.org/pdf/1103.4934
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    Bibliographic Info

    Paper provided by arXiv.org in its series Papers with number 1103.4934.

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    Date of creation: Mar 2011
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    Handle: RePEc:arx:papers:1103.4934

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    1. L.C.G. Rogers, 2001. "The relaxed investor and parameter uncertainty," Finance and Stochastics, Springer, vol. 5(2), pages 131-154.
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    Cited by:
    1. Richard J. Martin, 2012. "Optimal multifactor trading under proportional transaction costs," Papers 1204.6488, arXiv.org.
    2. 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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