Rebalancing With Transaction Costs: Theory, Simulations, and Actual Data

41 Pages Posted: 16 Dec 2019

See all articles by Rim El Bernoussi

Rim El Bernoussi

Cronos Finance SA

Michael Rockinger

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Date Written: November 29, 2019

Abstract

In the absence of transaction costs and the presence of independent returns, a buy-and-hold strategy can be shown to generate higher expected returns than a fixed-weight strategy, where the portfolio weights are regularly readjusted/rebalanced to some initial level. This higher expected return comes, however, at a cost: higher volatility. The resulting trade-off leads to different rankings of the Sharpe ratio depending on the statistical moments of the assets. We theoretically discuss causes affecting the ranking of the Sharpe ratio, and we introduce an easy-to-implement methodology to deal with proportional transaction costs. Under transaction costs, the buy-and-hold strategy as the cheaper approach should be the winner. In various simulation experiments, we investigate the relevance of transaction costs on rebalancing strategies. Eventually, we consider a realistic portfolio with a risk-free asset, bonds, and various stock indices that allows us to demonstrate that in practice, as long as transaction costs remain small, rebalancing has value for realistic portfolios.

Keywords: Portfolio rebalancing, Dynamic trading, Portfolio allocation, Buy-and-hold, Transaction costs, Insured portfolio

JEL Classification: G11, G15, C61, C63

Suggested Citation

El Bernoussi, Rim and Rockinger, Georg Michael, Rebalancing With Transaction Costs: Theory, Simulations, and Actual Data (November 29, 2019). Available at SSRN: https://ssrn.com/abstract=3495461 or http://dx.doi.org/10.2139/ssrn.3495461

Rim El Bernoussi

Cronos Finance SA ( email )

Chemin de la damataire 28
Lausanne, 1005
Switzerland
+41213312802 (Phone)

Georg Michael Rockinger (Contact Author)

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne) ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland
+41 21 728 3348 (Phone)
+41+21 692 3435 (Fax)

HOME PAGE: http://www.hec.unil.ch/mrockinger

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

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

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