Optimal Portfolio Selection with Transaction Costs and Finite Horizons

Abstract

We examine the optimal trading strategy for a CRRA investor who maximizes the expected utility of wealth on a finite date and faces transaction costs. Closed-form solutions are obtained when this date is uncertain. We then show a sequence of analytical solutions converge to the solution to the problem with a deterministic finite horizon. Consistent with the common life-cycle investment advice, the optimal trading strategy is found to be horizon dependent and largely buy and hold. Moreover, it might be optimal for the investor in our model not to buy any stock, even when the risk premium is positive. Further analysis of the optimal policy is also provided. Much of this work was completed while M. Loewenstein was at Washington University in St. Louis. We are grateful to an anonymous referee for useful suggestions. We also thank Jerome Detemple, Phil Dybvig, Gary Gorton

Asset Prices in General Equilibrium with Recursive Utility and Illiquidity Induced by Transactions Costs

“…8 This includes the work in Davis and Norman (1990), Dumas and Luciano (1991), Gennotte and Jung (1994), Bertsimas and Lo (1998), Schroder (1998), Balduzzi and Lynch (1999), Lynch and Balduzzi (2000), Liu and Loewenstein (2002), Liu (2004), and Garleânu and Pedersen (2013). See also Ang, Papanikolaou, identify the "region of no-trade" where, because of transaction costs, an investor finds it optimal not to rebalance her portfolio even though asset prices have changed.…”

Optimal Asset Allocation With Transaction Costs

“…Leland [7] Leland [7] Gennotte and Jung [5] Leland [7] CRRA ( ) (Gennotte and Jung [5], Liu and Loewenstein [8])…”

Dynamic Portfolio Choice with Linear Rebalancing Rules

“…Following this paper, there has been a significant literature aiming to incorporate the impact of various frictions, such as transaction costs, on the optimal portfolio choice 1 . Liu and Loewenstein (2002) study the optimal trading strategy for a constant relative risk aversion (CRRA) investor in the presence of transaction costs and obtain closed-form solutions when the finite horizon is uncertain. De-1 The work of Constantinides (1986) is an early example that studies the impact of proportional transaction costs on the optimal investment decision and the liquidity premium in the context of the capital asset pricing model (CAPM).…”