Dynamic portfolio optimization with transaction costs and state-dependent drift

Jan Palczewski, Rolf Poulsen, Klaus Schenk-Hoppé and Huamao Wang

European Journal of Operational Research, 2015, vol. 243, issue 3, 921-931

Abstract: The problem of dynamic portfolio choice with transaction costs is often addressed by constructing a Markov Chain approximation of the continuous time price processes. Using this approximation, we present an efficient numerical method to determine optimal portfolio strategies under time- and state-dependent drift and proportional transaction costs. This scenario arises when investors have behavioral biases or the actual drift is unknown and needs to be estimated. Our numerical method solves dynamic optimal portfolio problems with an exponential utility function for time-horizons of up to 40 years. It is applied to measure the value of information and the loss from transaction costs using the indifference principle.

Keywords: Dynamic programming; Numerical methods; State-dependent drift; Transaction costs; Markov Chain approximation (search for similar items in EconPapers)
Date: 2015
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:243:y:2015:i:3:p:921-931

DOI: 10.1016/j.ejor.2014.12.040

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