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Dynamic Trading with Predictable Returns and Transaction Costs

Nicolae B. Garleanu and Lasse Pedersen

No 15205, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We derive a closed-form optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with different mean-reversion speeds. The optimal strategy is characterized by two principles: 1) aim in front of the target and 2) trade partially towards the current aim. Specifically, the optimal updated portfolio is a linear combination of the existing portfolio and an "aim portfolio," which is a weighted average of the current Markowitz portfolio (the moving target) and the expected Markowitz portfolios on all future dates (where the target is moving). Intuitively, predictors with slower mean reversion (alpha decay) get more weight in the aim portfolio. We implement the optimal strategy for commodity futures and find superior net returns relative to more naive benchmarks.

JEL-codes: G11 G12 (search for similar items in EconPapers)
Date: 2009-08
New Economics Papers: this item is included in nep-mic and nep-mst
Note: AP
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Citations: View citations in EconPapers (5) Track citations by RSS feed

Published as "Dynamic Trading with Predictable Returns and Transaction Costs" (with Lasse Heje Pedersen). Journal of Finance, vol. 68 (2013), issue 6, pp. 2309-2340.

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Journal Article: Dynamic Trading with Predictable Returns and Transaction Costs (2013) Downloads
Working Paper: Dynamic Trading with Predictable Returns and Transaction Costs (2009) Downloads
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