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Delivering Left-Skewed Portfolio Payoff Distributions in the Presence of Transaction Costs

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  • Jacek B Krawczyk

    () (Victoria University of Wellington, School of Economics and Finance, PO Box 600, Wellington 6140, New Zealand)

Abstract

For pension-savers, a low payoff is a financial disaster. Such investors will most likely prefer left-skewed payoff distributions over right-skewed payoff distributions. We explore how such distributions can be delivered. Cautious-relaxed utility measures are cautious in ensuring that payoffs don’t fall much below a reference value, but relaxed about exceeding it. We find that the payoff distribution delivered by a cautious-relaxed utility measure has appealing features which payoff distributions delivered by traditional utility functions don’t. In particular, cautious-relaxed distributions can have the mass concentrated on the left, hence be left-skewed. However, cautious-relaxed strategies prescribe frequent portfolio adjustments which may be expensive if transaction costs are charged. In contrast, more traditional strategies can be time-invariant. Thus we investigate the impact of transaction costs on the appeal of cautious-relaxed strategies. We find that relatively high transaction fees are required for the cautious-relaxed strategy to lose its appeal. This paper contributes to the literature which compares utility measures by the payoff distributions they produce and finds that a cautious-relaxed utility measure will deliver payoffs that many investors will prefer.

Suggested Citation

  • Jacek B Krawczyk, 2015. "Delivering Left-Skewed Portfolio Payoff Distributions in the Presence of Transaction Costs," Risks, MDPI, Open Access Journal, vol. 3(3), pages 1-20, August.
  • Handle: RePEc:gam:jrisks:v:3:y:2015:i:3:p:318-337:d:54631
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    References listed on IDEAS

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    12. Paul A. Samuelson, 2011. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," World Scientific Book Chapters,in: THE KELLY CAPITAL GROWTH INVESTMENT CRITERION THEORY and PRACTICE, chapter 31, pages 465-472 World Scientific Publishing Co. Pte. Ltd..
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    More about this item

    Keywords

    portfolio management; payoff distributions; pension funds; transaction costs;

    JEL classification:

    • C - Mathematical and Quantitative Methods
    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M2 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics
    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • K2 - Law and Economics - - Regulation and Business Law

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