Mean Reversion Pays, but Costs
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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- 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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