Dynamic Portfolio Optimization with Transaction Costs and State-Dependent Drift
Norwegian School of Economics (NHH), Department of Finance Working Paper No. 2014-1
38 Pages Posted: 31 Oct 2013 Last revised: 13 Jan 2014
Date Written: January 6, 2014
We present an efficient numerical method to determine optimal portfolio strategies under time- and state-dependent drift and proportional transaction costs. This scenario arises when investors have behavioral biases or the actual drift is unknown and needs to be estimated. The numerical method solves dynamic optimal portfolio problems for time-horizons of up to 40 years. It is applied to measure the value of information and the loss from transaction costs using the indifference principle.
Keywords: Portfolio choice, State-dependent drift, Transaction costs, Numerical methods, Dynamic programming
JEL Classification: C61, G11
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