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Optimal Portfolio Selection with Transaction Costs

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  • Phelim Boyle
  • Xiaodong Lin

Abstract

This paper examines the lifetime portfolio-selection problem in the presence of transaction costs. Using a discrete time approach, we develop analytical expressions for the investor's indirect utility function and also for the boundaries of the no-transactions region. The economy consists of a single risky asset and a riskless asset. Transactions in the risky asset incur proportional transaction costs. The investor has a power utility function and is assumed to maximize expected utility of end-of-period wealth. We illustrate the solution procedure in the case in which the returns on the risky asset follow a multiplicative binomial process. Our paper both complements and extends the recent work by Gennotte and Jung (1994), which used numerical approximations to tackle this problem.

Suggested Citation

  • Phelim Boyle & Xiaodong Lin, 1997. "Optimal Portfolio Selection with Transaction Costs," North American Actuarial Journal, Taylor & Francis Journals, vol. 1(2), pages 27-39.
    • Handle: RePEc:taf:uaajxx:v:1:y:1997:i:2:p:27-39
    DOI: 10.1080/10920277.1997.10595602
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    Cited by:

    1. Valeri Zakamouline, 2005. "A unified approach to portfolio optimization with linear transaction costs," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 62(2), pages 319-343, November.
    2. Chen, Xu & Yang, Xiang-qun, 2015. "Optimal consumption and investment problem with random horizon in a BMAP model," Insurance: Mathematics and Economics, Elsevier, vol. 61(C), pages 197-205.
    3. Kozhan, Roman & Schmid, Wolfgang, 2009. "Asset allocation with distorted beliefs and transaction costs," European Journal of Operational Research, Elsevier, vol. 194(1), pages 236-249, April.
    4. Tak Siu, 2012. "A BSDE approach to risk-based asset allocation of pension funds with regime switching," Annals of Operations Research, Springer, vol. 201(1), pages 449-473, December.
    5. Li, Wei & Lam, Kin, 2002. "Optimal market timing strategies under transaction costs," Omega, Elsevier, vol. 30(2), pages 97-108, April.
    6. Yongyang Cai & Kenneth L. Judd & Rong Xu, 2013. "Numerical Solution of Dynamic Portfolio Optimization with Transaction Costs," NBER Working Papers 18709, National Bureau of Economic Research, Inc.
    7. Michal Czerwonko & Stylianos Perrakis, 2016. "Portfolio Selection with Transaction Costs and Jump-Diffusion Asset Dynamics I: A Numerical Solution," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 6(04), pages 1-23, December.
    8. Kozhan, Roman, 2006. "Multiple Priors And No-Transaction Region," Working Paper Series 2006,4, European University Viadrina Frankfurt (Oder), The Postgraduate Research Programme Capital Markets and Finance in the Enlarged Europe.
    9. Arjmandi, Nabi, 2023. "Optimal Portfolio Rebalancing with Sweep Under Transaction Cost," MPRA Paper 117162, University Library of Munich, Germany.

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