Multiple Risky Assets, Transaction Costs, and Return Predictability: Allocation Rules and Implications for U.S. Investors

Anthony W. Lynch and Sinan Tan

Journal of Financial and Quantitative Analysis, 2010, vol. 45, issue 4, 1015-1053

Abstract: This paper numerically solves the decision problem of a multiperiod constant relative risk aversion individual who faces transaction costs and has access to two risky assets, both with predictable returns. With proportional transaction costs and independent and identically distributed returns, we numerically find the rebalancing rule to be a no-trade region for the portfolio weights with rebalancing to the boundary. The shape of the no-trade region depends on the correlation between the two risky assets. With predictable returns, there is instead a no-trade region for each state. We also examine several important economic questions, including the utility cost of not being able to buy on margin or short stock.

Date: 2010
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