An Algorithm for Portfolio Optimization with Transaction Costs

Michael J. Best () and Jaroslava Hlouskova
Additional contact information
Michael J. Best: Department of Combinatorics and Optimization, Faculty of Mathematics, University of Waterloo, Waterloo, Ontario, N2L 3G1 Canada

Management Science, 2005, vol. 51, issue 11, 1676-1688

Abstract: We consider the problem of maximizing an expected utility function of n assets, such as the mean-variance or power-utility function. Associated with a change in an asset's holdings from its current or target value is a transaction cost. This cost must be accounted for in practical problems. A straightforward way of doing so results in a 3n-dimensional optimization problem with 3n additional constraints. This higher dimensional problem is computationally expensive to solve. We present a method for solving the 3n-dimensional problem by solving a sequence of n-dimensional optimization problems, which accounts for the transaction costs implicitly rather than explicitly. The method is based on deriving the optimality conditions for the higher-dimensional problem solely in terms of lower-dimensional quantities. The new method is compared to the barrier method implemented in Cplex in a series of numerical experiments. With small but positive transaction costs, the barrier method and the new method solve problems in roughly the same amount of execution time. As the size of the transaction cost increases, the new method outperforms the barrier method by a larger and larger factor.

Keywords: convex programming; portfolio optimization; transaction costs (search for similar items in EconPapers)
Date: 2005
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (15)

Downloads: (external link)
http://dx.doi.org/10.1287/mnsc.1050.0418 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:51:y:2005:i:11:p:1676-1688

Access Statistics for this article

More articles in Management Science from INFORMS Contact information at EDIRC.
Bibliographic data for series maintained by Chris Asher ().