Dynamic Asset Allocation with Predictable Returns and Transaction Costs

57 Pages Posted: 17 Jun 2015

See all articles by Pierre Collin-Dufresne

Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; National Bureau of Economic Research (NBER)

Kent D. Daniel

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Ciamac C. Moallemi

Columbia Business School - Decision Risk and Operations

Mehmet Saglam

University of Cincinnati - Department of Finance - Real Estate

Date Written: June 15, 2015

Abstract

We propose a simple approach to dynamic multi-period portfolio choice with transaction costs that is tractable in settings with a large number of securities, realistic return dynamics with multiple risk factors, many predictor variables, and stochastic volatility. We obtain a closed-form solution for an optimal trading rule when the problem is restricted to a broad class of strategies we define as 'linearity generating strategies' (LGS). When restricted to this class, the non-linear dynamic optimization problem reduces to a deterministic linear-quadratic optimization problem in the parameters of the trading strategies. We show that the LGS approach dominates several alternatives in realistic settings, and in particular when the covariance structure and transaction costs are stochastic.

Keywords: Dynamic Asset Allocation, Return Predictability, Transaction Costs

JEL Classification: G11

Suggested Citation

Collin-Dufresne, Pierre and Daniel, Kent D. and Moallemi, Ciamac C. and Saglam, Mehmet, Dynamic Asset Allocation with Predictable Returns and Transaction Costs (June 15, 2015). Available at SSRN: https://ssrn.com/abstract=2618910 or http://dx.doi.org/10.2139/ssrn.2618910

Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne ( email )

Quartier UNIL-Dorigny, Bâtiment Extranef, # 211
40, Bd du Pont-d'Arve
CH-1015 Lausanne, CH-6900
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Kent D. Daniel

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States
212-854-4679 (Phone)
212-854-4679 (Fax)

HOME PAGE: http://kentdaniel.net/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ciamac C. Moallemi

Columbia Business School - Decision Risk and Operations ( email )

New York, NY
United States

HOME PAGE: http://moallemi.com/ciamac

Mehmet Saglam (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

Carl H. Lindner College of Business
Cincinnati, OH 45221
United States
(513) 556-9108 (Phone)

HOME PAGE: http://homepages.uc.edu/~saglammt/

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