Test for Trading Costs Effect in a Portfolio Selection Problem with Recursive Utility

Marine Carrasco and N’Golo Koné

Journal of Financial Econometrics, 2024, vol. 22, issue 4, 908-953

Abstract: This article addresses a portfolio selection problem with trading costs on stock market. More precisely, we develop a simple generalized method of moments (GMM)-based test procedure to test the significance of trading costs effect in the economy with a flexible form of transaction costs. We also propose a two-step procedure to test overidentifying restrictions in our GMM estimation. In an empirical analysis, we apply our test procedures to the class of anomalies used in Novy-Marx and Velikov (2016). We show that transaction costs have a significant effect on investors’ behavior for many anomalies. In that case, investors significantly improve the out-of-sample performance of their portfolios by accounting for trading costs.

Keywords: portfolio selection; recursive utility; testing overidentifying restrictions; transaction costs (search for similar items in EconPapers)
JEL-codes: C12 G11 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Test for Trading Costs Effect in a Portfolio Selection Problem with Recursive Utility (2023)
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