Combining Alpha Streams with Costs

The Journal of Risk 17(3) (2015) 57-78

21 Pages Posted: 21 May 2014 Last revised: 24 Feb 2015

See all articles by Zura Kakushadze

Zura Kakushadze

Quantigic Solutions LLC; Free University of Tbilisi

Multiple version iconThere are 2 versions of this paper

Date Written: July 7, 2014

Abstract

We discuss investment allocation to multiple alpha streams traded on the same execution platform with internal crossing of trades and point out differences with allocating investment when alpha streams are traded on separate execution platforms with no crossing. First, in the latter case allocation weights are non-negative, while in the former case they can be negative. Second, the effects of both linear and nonlinear (impact) costs are different in these two cases due to turnover reduction when the trades are crossed. Third, the turnover reduction depends on the universe of traded alpha streams, so if some alpha streams have zero allocations, turnover reduction needs to be recomputed, hence an iterative procedure. We discuss an algorithm for finding allocation weights with crossing and linear costs. We also discuss a simple approximation when nonlinear costs are added, making the allocation problem tractable while still capturing nonlinear portfolio capacity bound effects. We also define "regression with costs" as a limit of optimization with costs, useful in often-occurring cases with singular alpha covariance matrix.

Keywords: hedge fund, alpha stream, crossing trades, transaction costs, impact, portfolio turnover, investment allocation, weight optimization

JEL Classification: G00

Suggested Citation

Kakushadze, Zura, Combining Alpha Streams with Costs (July 7, 2014). The Journal of Risk 17(3) (2015) 57-78. Available at SSRN: https://ssrn.com/abstract=2438687 or http://dx.doi.org/10.2139/ssrn.2438687

Zura Kakushadze (Contact Author)

Quantigic Solutions LLC ( email )

1127 High Ridge Road #135
Stamford, CT 06905
United States
6462210440 (Phone)
6467923264 (Fax)

HOME PAGE: http://www.linkedin.com/in/zurakakushadze

Free University of Tbilisi ( email )

Business School and School of Physics
240, David Agmashenebeli Alley
Tbilisi, 0159
Georgia

Register to save articles to
your library

Register

Paper statistics

Downloads
1,734
rank
8,882
Abstract Views
6,761
PlumX Metrics