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Optimal investment in the foreign exchange market with proportional transaction costs

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  • Luitgard Veraart

Abstract

We consider an investor in the foreign exchange market who can trade in two currencies, domestic and foreign. The investor seeks to optimize the expected mark-to-market value of the portfolio while aiming for a certain target proportion of the holdings in foreign currency compared with total wealth. This target proportion is exogenously given and can be thought of as a constraint imposed by risk management. The exchange rate process is modeled as a geometric Brownian motion. Proportional transaction costs are charged. We present a numerical algorithm that solves the resulting free boundary problem.

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  • Luitgard Veraart, 2010. "Optimal investment in the foreign exchange market with proportional transaction costs," Quantitative Finance, Taylor & Francis Journals, vol. 11(4), pages 631-640.
    • Handle: RePEc:taf:quantf:v:11:y:2010:i:4:p:631-640
    DOI: 10.1080/14697680903460150
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    References listed on IDEAS

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    1. Lu, Jin-Ray & Chan, Chih-Ming & Wen, Mei-Hui, 2012. "Which demands affect optimal international portfolio choices?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 22(5), pages 1292-1306.

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