OPTIMAL PORTFOLIO SELECTION STRATEGIES IN THE PRESENCE OF TRANSACTION COSTS

Qiang Meng () and Ananda Weerasinghe
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Qiang Meng: Department of Mathematics, Iowa State University, Ames, IA 50011, USA
Ananda Weerasinghe: Department of Mathematics, Iowa State University, Ames, IA 50011, USA

International Journal of Theoretical and Applied Finance (IJTAF), 2006, vol. 09, issue 04, 619-641

Abstract: We consider an investor who has available a bank account (risk free asset) and a stock (risky asset). It is assumed that the interest rate for the risk free asset is zero and the stock price is modeled by a diffusion process. The wealth can be transferred between the two assets under a proportional transaction cost. Investor is allowed to obtain loans from the bank and also to short-sell the risky asset when necessary. The optimization problem addressed here is to maximize the probability of reaching a financial goal a before bankruptcy and to obtain an optimal portfolio selection policy. Our optimal policy is a combination of local-time processes and jumps. In the interesting case, it is determined by a non-linear switching curve on the state space. This work is a generalization of Weerasinghe [20], where this switching boundary is a vertical line segment.

Keywords: Optimal investment; stochastic differential equations; transaction costs (search for similar items in EconPapers)
Date: 2006
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DOI: 10.1142/S021902490600369X

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