Mean-Variance Portfolio Rebalancing with Transaction Costs

Abstract

As in continuous time, the nontrading region (NTR) in a mean-variance model with fixed, proportional, and quadratic trading costs is a singleton only for pure quadratic costs. Utility loss from costs is approximately proportional at small cost levels, and approximately constant at large cost levels. Trading can be to the interior of the NTR (fixed costs with or without proportional costs), the exterior of the NTR (quadratic costs with or without proportional costs), or the boundary (pure proportional costs). Absent fixed costs, the NTR is a multidimensional parallelogram. An application shows how to improve on traditional symmetric futures overlay strategies.

Keywords: Transaction Costs, Mean-Variance, Optimization, Asset Allocation, Price Pressure

JEL Classification: C61, D23, G11