The risk of falling short: Implementation Shortfall variance in portfolio construction *
25 Pages Posted: 30 Jan 2022
Date Written: January 25, 2022
Abstract
Transaction cost variance introduces a risk often neglected in portfolio optimization. Adopting a mean-variance portfolio optimization problem, we show that including a transaction cost variance term can significantly impact the associated portfolios' performances. Transaction cost variance is estimated based on a transaction cost model constructed using proprietary data from a large institutional investment manager company. Using a standard time-series model setup for returns, we show that considering transaction cost variance leads to improved net risk-adjusted performance.
Keywords: Portfolio optimization, Implementation Shortfall, Time-series models. JEL Classification: C01, C32, C51, C52, C61, G11, G12
JEL Classification: C01, C32, C51, C52, C61, G11, G12
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