Optimal Dynamic Asset Allocation with Transaction Costs: The Role of Hedging Demands

Pierre Collin-Dufresne, Kent D. Daniel and Mehmet Saglam
Additional contact information
Pierre Collin-Dufresne: Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; NBER
Kent D. Daniel: Columbia University; NBER
Mehmet Saglam: University of Cincinnati

No 23-38, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: A number of papers have solved for the optimal dynamic portfolio strategy when expected returns are time-varying and trading is costly, but only for agents with myopic utility. Non-myopic agents benefit from hedging against shocks to the investment opportunity set even when transaction costs are zero. In this paper, we propose a solution to the dynamic portfolio allocation problem for non-myopic agents faced with a stochastic investment opportunity set, when trading is costly. We show that the agent's optimal policy is to trade toward an "aim" portfolio, the makeup of which depends both on transaction costs and on each asset's correlation with changes in the investment opportunity set. The speed at which the agent should trade towards the aim portfolio depends both on the shock's persistence and on the extent to which the shock can be effectively hedged.

Keywords: portfolio choice; dynamic models; transaction costs; hedging demand; price impact; mean-variance (search for similar items in EconPapers)
JEL-codes: D53 G11 G12 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2023-06
References: Add references at CitEc
Citations:

Downloads: (external link)
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4294336 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp2338

Access Statistics for this paper

More papers in Swiss Finance Institute Research Paper Series from Swiss Finance Institute Contact information at EDIRC.
Bibliographic data for series maintained by Ridima Mittal ().