High-Frequency Trading with Fractional Brownian Motion
27 Pages Posted: 16 Aug 2019 Last revised: 17 Jul 2020
Date Written: August 13, 2019
In the high-frequency limit, conditional expected increments of fractional Brownian motion converge to a white noise, shedding their dependence on the path history and the forecasting horizon, and making dynamic optimization problems tractable. We find an explicit formula for locally mean-variance optimal strategies and their performance for an asset price that follows fractional Brownian motion. Without trading costs, risk-adjusted profits are linear in the trading horizon and rise asymmetrically as the Hurst exponent departs from Brownian motion, remaining finite as the exponent reaches zero while diverging as it approaches one. Trading costs penalize numerous portfolio updates from short-lived signals, leading to a finite trading frequency, which can be chosen so that the effect of trading costs is arbitrarily small, depending on the required speed of convergence to the high-frequency limit.
Keywords: fractional Brownian motion, transaction costs, high frequency, trading
JEL Classification: G11
Suggested Citation: Suggested Citation