The Role of Transaction Costs and Risk Aversion When Selecting Between One and Two Regimes for Portfolio Models

Applied Economics Letters, Forthcoming

14 Pages Posted: 20 Sep 2017 Last revised: 15 May 2018

See all articles by Emmanouil Platanakis

Emmanouil Platanakis

University of Bath - School of Management

Athanasios Sakkas

Athens University of Economics and Business - Department of Accounting and Finance

Charles Sutcliffe

University of Reading - ICMA Centre

Date Written: May 10, 2018

Abstract

Estimation errors in the inputs are the main problem when applying portfolio analysis, and Markov regime switching models have been shown to reduce these errors. We investigate whether the use of two regime models remains superior across a range of values of risk aversion and transaction costs, in the presence of skewness and kurtosis and no short sales. Our results for US data suggest that, due to differences in their risk preferences and transactions costs, most retail investors may prefer to use one regime models, while investment banks prefer to use two regime models.

Keywords: Portfolio theory; regime shifting; transaction costs; risk aversion; constant relative risk aversion

JEL Classification: G11

Suggested Citation

Platanakis, Emmanouil and Sakkas, Athanasios and Sutcliffe, Charles M., The Role of Transaction Costs and Risk Aversion When Selecting Between One and Two Regimes for Portfolio Models (May 10, 2018). Applied Economics Letters, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3039447 or http://dx.doi.org/10.2139/ssrn.3039447

Emmanouil Platanakis

University of Bath - School of Management ( email )

Claverton Down
Bath, BA2 7AY
United Kingdom

Athanasios Sakkas

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece

Charles M. Sutcliffe (Contact Author)

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading RG6 6BA
United Kingdom

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