Dynamic Trading with Predictable Returns and Transaction Costs

Nicolae Gârleanu and Lasse Pedersen

Journal of Finance, 2013, vol. 68, issue 6, 2309-2340

Abstract: We derive a closed‐form optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with different mean‐reversion speeds. The optimal strategy is characterized by two principles: (1) aim in front of the target, and (2) trade partially toward the current aim. Specifically, the optimal updated portfolio is a linear combination of the existing portfolio and an “aim portfolio,” which is a weighted average of the current Markowitz portfolio (the moving target) and the expected Markowitz portfolios on all future dates (where the target is moving). Intuitively, predictors with slower mean‐reversion (alpha decay) get more weight in the aim portfolio. We implement the optimal strategy for commodity futures and find superior net returns relative to more naive benchmarks.

Date: 2013
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Citations: View citations in EconPapers (172)

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https://doi.org/10.1111/jofi.12080

Related works:
Working Paper: Dynamic Trading with Predictable Returns and Transaction Costs (2009)
Working Paper: Dynamic Trading with Predictable Returns and Transaction Costs (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:68:y:2013:i:6:p:2309-2340

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