Building an Optimal Portfolio in Discrete Time in the Presence of Transaction Costs

Colin Atkinson and Emmeline Storey

Applied Mathematical Finance, 2010, vol. 17, issue 4, pages 323-357

Abstract: Portfolio theory covers different approaches to the construction of a portfolio offering maximum expected returns for a given level of risk tolerance where the goal is to find the optimal investment rule. Each investor has a certain utility for money which is reflected by the choice of a utility function. In this article, a risk averse power utility function is studied in discrete time for a large class of underlying probability distribution of the returns of the asset prices. Each investor chooses, at the beginning of an investment period, the feasible portfolio allocation which maximizes the expected value of the utility function for terminal wealth. Effects of both large and small proportional transaction costs on the choice of an optimal portfolio are taken into account. The transaction regions are approximated by using asymptotic methods when the proportional transaction costs are small and by using expansions about critical points for large transaction costs.

Keywords: Portfolio optimization; transaction costs; dynamic programming; utility maximization (search for similar items in EconPapers)
Date: 2010
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