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

See all articles by Jan Palczewski

Jan Palczewski

University of Leeds - School of Mathematics

Rolf Poulsen

University of Copenhagen - Department of Statistics and Operations Research

Klaus Reiner Schenk-Hoppé

University of Manchester - Department of Economics; Norwegian School of Economics (NHH) - Department of Finance

Huamao Wang

University of Kent - Kent Business School

Date Written: January 6, 2014

Abstract

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

Suggested Citation

Palczewski, Jan and Poulsen, Rolf and Schenk-Hoppé, Klaus Reiner and Wang, Huamao, Dynamic Portfolio Optimization with Transaction Costs and State-Dependent Drift (January 6, 2014). Norwegian School of Economics (NHH), Department of Finance Working Paper No. 2014-1. Available at SSRN: https://ssrn.com/abstract=2346304 or http://dx.doi.org/10.2139/ssrn.2346304

Jan Palczewski

University of Leeds - School of Mathematics ( email )

Leeds, LS2 9JT
United Kingdom

HOME PAGE: http://www.maths.leeds.ac.uk/~jp

Rolf Poulsen

University of Copenhagen - Department of Statistics and Operations Research ( email )

Universitetsparken 5
DK-2100
Denmark
+45 (353) 20685 (Phone)

Klaus Reiner Schenk-Hoppé

University of Manchester - Department of Economics ( email )

Arthur Lewis Building
Oxford Road
Manchester, M13 9PL
United Kingdom

Norwegian School of Economics (NHH) - Department of Finance ( email )

Helleveien 30
N-5045 Bergen
Norway

Huamao Wang (Contact Author)

University of Kent - Kent Business School ( email )

Sibson Building
Canterbury, Kent CT2 7FS
United Kingdom

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