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Portfolio models with return forecasting and transaction costs

Jing-Rung Yu, Wan-Jiun Paul Chiou, Wen-Yi Lee and Shun-Ji Lin

International Review of Economics & Finance, 2020, vol. 66, issue C, 118-130

Abstract: In this paper, we advance portfolio models by incorporating return projection and further analyze their realized performance. To ensure practicality, the transaction costs and the optimization of short-selling weights are taken into account in portfolio rebalancing. Using the daily returns of international ETFs over a period of 14 years, the empirical results show that including return forecasting improves the realized performance due to more efficient asset allocation but not a reduction in trading costs. The models that are based on trade-off between return and volatility, such as the mean-variance and Omega models, show higher increases in performance than those mainly focus on controlling loss, such as the linearized value-at-risk, the conditional value-at-risk, and the downside risk. The superiority of forecasting risky portfolios over the equally-weighted diversification varies intertemporarily across various portfolio models. The benefit of inclusion of prediction is larger when the market is less volatile.

Keywords: Investment analysis; Portfolio rebalancing; Return forecasting; Multiple objectives; Transaction costs (search for similar items in EconPapers)
JEL-codes: C61 G11 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.iref.2019.11.002

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