Optimal Asset Rebalancing in the Presence of Transactions Costs
AbstractWe examine the optimal trading strategy for an investment fund which wishes to maintain two assets in fixed proportions, e.g. 60/40 in stocks and bonds. Transactions costs are assumed to be proportional to the amount of each asset traded. We show that the optimal policy involves a band about the target stock proportion. As long as the actual stock/bond ratio remains inside this band, no trading should occur. If the ratio goes outside the band, trading should be undertaken to move the ratio to the nearest edge of the band. We compute the optimal band and resulting annual turnover and tracking error of the optimal policy, as a function of transactions costs, asset volatility, the target asset mix, and other parameters. We show how changes in transactions costs and other parameters affect the size of the no-trade band, turnover, and tracking error. Compared to a quarterly rebalancing strategy an example demonstrates that the optimal strategy can reduce turnover by almost 50 percent.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by EconWPA in its series Finance with number 9610004.
Date of creation: 23 Oct 1996
Date of revision: 29 Oct 1996
Note: 21pp; WordPerfect/WIN file
Contact details of provider:
Web page: http://18.104.22.168
Other versions of this item:
- Hayne Leland., 1996. "Optimal Asset Rebalancing in the Presence of Transactions Costs," Research Program in Finance Working Papers RPF-261, University of California at Berkeley.
- G - Financial Economics
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Dumas, Bernard & Luciano, Elisa, 1991. " An Exact Solution to a Dynamic Portfolio Choice Problem under Transactions Costs," Journal of Finance, American Finance Association, vol. 46(2), pages 577-95, June.
- Constantinides, George M, 1986. "Capital Market Equilibrium with Transaction Costs," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 842-62, August.
- Hayne Leland and Gregory Connor., 1995. "Optimal Cash Management for Investment Funds," Research Program in Finance Working Papers RPF-244, University of California at Berkeley.
- Dumas, Bernard, 1991. "Super contact and related optimality conditions," Journal of Economic Dynamics and Control, Elsevier, vol. 15(4), pages 675-685, October.
- Hayne E. Leland., 1984.
"Option Pricing and Replication with Transactions Costs,"
Research Program in Finance Working Papers
144, University of California at Berkeley.
- Leland, Hayne E, 1985. " Option Pricing and Replication with Transactions Costs," Journal of Finance, American Finance Association, vol. 40(5), pages 1283-1301, December.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (EconWPA).
If references are entirely missing, you can add them using this form.