Optimal Portfolio Selection for the Small Investor Considering Risk and Transaction Costs

21 Pages Posted: 28 Feb 2008 Last revised: 5 Aug 2013

Date Written: February 1, 2008

Abstract

A direct application of classical portfolio selection theory is problematic for the small investor, since transaction costs in the form of bank and broker fees exist. Particularly minimum fees force the investor to choose a rather small selection of assets. This leads to an optimization problem which juxtaposes the transaction costs against the risk costs arising with portfolios consisting of only a few assets. Despite the non-convex and thus complex optimization, an algorithmic solution turns out to be very fast and precise. An empirical study shows that for smaller investment volumes, transaction costs dominate risk costs, so that optimal portfolios contain only a very small number of assets.

Keywords: portfolio selection, transaction costs, non-convex optimization

JEL Classification: C61, G11

Suggested Citation

Baule, Rainer, Optimal Portfolio Selection for the Small Investor Considering Risk and Transaction Costs (February 1, 2008). OR Spectrum 32 (1/2010), 61–76. Available at SSRN: https://ssrn.com/abstract=1098335

Rainer Baule (Contact Author)

University of Hagen ( email )

Universitaetsstrasse 41
Hagen, 58097
Germany

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