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A Stochastic Multi-stage Trading Cost model in optimal portfolio selection

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  • Sabastine Mushori
  • Delson Chikobvu

Abstract

We propose a multi-stage stochastic trading cost model in optimal portfolio selection. This strategy captures uncertainty in implicit transaction costs incurred by an investor during initial trading and in subsequent rebalancing of the portfolio. We assume that implicit costs are stochastic as are asset returns. We use mean absolute deviation as our risk and apply the model to securities on the Johannesburg Stock Market. The model generates optimal portfolios by minimizing total implicit transaction costs incurred. It provides least-cost optimal portfolios whose net wealths are better than those gener- ated by the mean-variance, minimax and mean absolute deviation models.

Suggested Citation

  • Sabastine Mushori & Delson Chikobvu, 2016. "A Stochastic Multi-stage Trading Cost model in optimal portfolio selection," Journal of Economics and Econometrics, Economics and Econometrics Society, vol. 59(3), pages 32-66.
    • Handle: RePEc:eei:journl:v:59:y:2016:i:3:p:32-66
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    Keywords

    D23; C61;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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