MINIMAL COST INDEX TRACKING UNDER NONLINEAR TRANSACTION COSTS AND MINIMAL TRANSACTION UNIT CONSTRAINTS

Hiroshi Konno () and Annista Wijayanayake ()
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Hiroshi Konno: Center for Research in Advanced Financial Technology, Tokyo Institute of Technology, Japan;
Annista Wijayanayake: Department of Industrial Engineering and Management, Tokyo Institute of Technology, Japan

International Journal of Theoretical and Applied Finance (IJTAF), 2001, vol. 04, issue 06, 939-957

Abstract: Index tracking is a very common and popular approach in portfolio management. When there is neither (nonconvex) transaction costs nor minimal transaction unit constraints, the problem can be formulated as a convex least square problem, so that it can be solved by standard methods. However, when the transaction cost is nonconvex and not negligible, or if there is a minimal unit constraint on the amount of transaction, the problem becomes a nonconvex minimization problem with discrete variables. In this paper, we will propose a branch and bound algorithm for solving this class of problems and show that it can solve an index tracking problem of practical size in a reasonable amount of computation time.

Keywords: Portfolio optimization; index tracking; concave transaction cost; minimal transaction unit; branch and bound algorithm; mean-absolute deviation model (search for similar items in EconPapers)
Date: 2001
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DOI: 10.1142/S0219024901001292

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