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Non-Linear Transaction Costs Inclusion in Mean-Variance Optimization

Author

Listed:
  • José Euclides de Melo Ferraz

    (Banco Itaú)

  • Christian Johannes Zimmer

    (Banco Itaú)

Abstract

In this article we propose a new way to include transaction costs into a mean-variance portfolio optimization. We consider brokerage fees, bid/ask spread and the market impact of the trade. A pragmatic algorithm is proposed, which approximates the optimal portfolio, and we can show that is converges in the absence of restrictions. Using Brazilian financial market data we compare our approximation algorithm with the results of a non-linear optimizer.

Suggested Citation

  • José Euclides de Melo Ferraz & Christian Johannes Zimmer, 2005. "Non-Linear Transaction Costs Inclusion in Mean-Variance Optimization," Brazilian Review of Finance, Brazilian Society of Finance, vol. 3(2), pages 195-221.
    • Handle: RePEc:brf:journl:v:3:y:2005:i:2:p:195-221
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    More about this item

    Keywords

    portfolio optimization; transaction costs; bid-ask spread; market impact;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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