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Test for Trading Costs Effect in a Portfolio Selection Problem with Recursive Utility

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  • Marine Carrasco
  • N’Golo Koné

Abstract

This article addresses a portfolio selection problem with trading costs on stock market. More precisely, we develop a simple generalized method of moments (GMM)-based test procedure to test the significance of trading costs effect in the economy with a flexible form of transaction costs. We also propose a two-step procedure to test overidentifying restrictions in our GMM estimation. In an empirical analysis, we apply our test procedures to the class of anomalies used in Novy-Marx and Velikov (2016). We show that transaction costs have a significant effect on investors’ behavior for many anomalies. In that case, investors significantly improve the out-of-sample performance of their portfolios by accounting for trading costs.

Suggested Citation

  • Marine Carrasco & N’Golo Koné, 2024. "Test for Trading Costs Effect in a Portfolio Selection Problem with Recursive Utility," Journal of Financial Econometrics, Oxford University Press, vol. 22(4), pages 908-953.
    • Handle: RePEc:oup:jfinec:v:22:y:2024:i:4:p:908-953.
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    File URL: http://hdl.handle.net/10.1093/jjfinec/nbad015
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    More about this item

    Keywords

    portfolio selection; recursive utility; testing overidentifying restrictions; transaction costs;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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