Optimal mean-reversion strategy in the presence of bid-ask spread and delays in capital allocations

Sergey Isaenko

Quantitative Finance, 2018, vol. 18, issue 12, 2051-2065

Abstract: A portfolio optimization problem for an investor who trades T-bills and a mean-reverting stock in the presence of proportional and convex transaction costs is considered. The proportional transaction cost represents a bid-ask spread, while the convex transaction cost is used to model delays in capital allocations. I utilize the historical bid-ask spread in US stock market and assume that the stock reverts on yearly basis, while an investor follows monthly changes in the stock price. It is found that proportional transaction cost has a relatively weak effect on the expected return and the Sharpe ratio of the investor's portfolio. Meantime, the presence of delays in capital allocations has a dramatic impact on the expected return and the Sharpe ratio of the investor's portfolio. I also find the robust optimal strategy in the presence of model uncertainty and show that the latter increases the effective risk aversion of the investor and makes her view the stock as more risky.

Date: 2018
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DOI: 10.1080/14697688.2018.1484151

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