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Portfolio Optimization over a Finite Horizon with Fixed and Proportional Transaction Costs and Liquidity Constraints

Author

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  • Stefano Baccarin

    (Department of Economics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino, Italy)

  • Daniele Marazzina

    (Department of Mathematics, Polytechnic University of Milano, Italy)

Abstract

We investigate a portfolio optimization problem for an agent who invests in two assets, a risk-free and a risky asset modeled by a geometric Brownian motion. The investor faces both fixed and proportional transaction costs and liquidity constraints. His objective is to maximize the expected utility from the portfolio liquidation at a terminal finite horizon. The model is formulated as a parabolic impulse control problem and we characterize the value function as the unique constrained viscosity solution of the associated quasi-variational inequality. We compute numerically the optimal policy by a an iterative finite element discretization technique, presenting extended numerical results in the case of a constant relative risk aversion utility function. Our results show that, even with small transaction costs and distant horizons, the optimal strategy is essentially a buy-and-hold trading strategy where the agent recalibrates his portfolio very few times. This contrasts sharply with the continuous interventions of the Merton's model without transaction costs.

Suggested Citation

  • Stefano Baccarin & Daniele Marazzina, 2013. "Portfolio Optimization over a Finite Horizon with Fixed and Proportional Transaction Costs and Liquidity Constraints," Working papers 017, Department of Economics, Social Studies, Applied Mathematics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino.
    • Handle: RePEc:tur:wpapnw:017
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    File URL: http://www.bemservizi.unito.it/repec/tur/wpapnw/m17.pdf
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    References listed on IDEAS

    as
    1. Vathana Ly Vath & Mohamed Mnif & Huyên Pham, 2007. "A model of optimal portfolio selection under liquidity risk and price impact," Finance and Stochastics, Springer, vol. 11(1), pages 51-90, January.
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    6. Baccarin, Stefano, 2009. "Optimal impulse control for a multidimensional cash management system with generalized cost functions," European Journal of Operational Research, Elsevier, vol. 196(1), pages 198-206, July.
    7. Marianne Akian & Agnès Sulem & Michael I. Taksar, 2001. "Dynamic Optimization of Long‐Term Growth Rate for a Portfolio with Transaction Costs and Logarithmic Utility," Mathematical Finance, Wiley Blackwell, vol. 11(2), pages 153-188, April.
    8. M. H. A. Davis & A. R. Norman, 1990. "Portfolio Selection with Transaction Costs," Mathematics of Operations Research, INFORMS, vol. 15(4), pages 676-713, November.
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    Cited by:

    1. Stefano Baccarin, 2013. "Optimal Consumption of a Generalized Geometric Brownian Motion with Fixed and Variable Intervention Costs," Working papers 021, Department of Economics, Social Studies, Applied Mathematics and Statistics (Dipartimento di Scienze Economico-Sociali e Matematico-Statistiche), University of Torino.

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    More about this item

    Keywords

    Portfolio Optimization; Quasi-variational Inequalities; Transaction Costs; Viscosity Solutions;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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