Combining Alpha Streams with Costs

22 Pages Posted: 24 Jun 2016

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: February 20, 2015

Abstract

In this paper, we discuss investment allocation to multiple alpha streams traded on the same execution platform with internal trade crossing. We then point out the differences between such a case and investment allocation when alpha streams are traded on separate execution platforms with no crossing. In the latter case, allocation weights are non-negative; in the former, they can be negative. The effects of linear and nonlinear (impact) costs are different in these two cases due to turnover reduction when the trades are crossed. 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 is required. 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, which is useful in often-occurring cases with a singular alpha co-variance matrix.

Keywords: alpha stream, crossing trades, transaction costs, impact, portfolio turnover, investment allocation

Suggested Citation

Kakushadze, Zura, Combining Alpha Streams with Costs (February 20, 2015). Journal of Risk, Vol. 17, No. 3, 2015, Available at SSRN: https://ssrn.com/abstract=2799654

Zura Kakushadze (Contact Author)

Quantigic Solutions LLC ( email )

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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

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