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Portfolio Selection with Small Transaction Costs and Binding Portfolio Constraints

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  • Johannes Muhle-Karbe
  • Ren Liu

Abstract

An investor with constant relative risk aversion and an infinite planning horizon trades a risky and a safe asset with constant investment opportunities, in the presence of small transaction costs and a binding exogenous portfolio constraint. We explicitly derive the optimal trading policy, its welfare, and implied trading volume. As an application, we study the problem of selecting a prime broker among alternatives with different lending rates and margin requirements. Moreover, we discuss how changing regulatory constraints affect the deposit rates offered for illiquid loans.

Suggested Citation

  • Johannes Muhle-Karbe & Ren Liu, 2012. "Portfolio Selection with Small Transaction Costs and Binding Portfolio Constraints," Papers 1205.4588, arXiv.org, revised Jan 2013.
    • Handle: RePEc:arx:papers:1205.4588
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    References listed on IDEAS

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