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Investment Strategies under Transactions Costs: The Finite Horizon Case

Directory : Faculty : Intellectual Contributions

Intellectual Contribution by Alan Jung

Contribution Title

Investment Strategies under Transactions Costs: The Finite Horizon Case

Publication

Management Science Journal

Co-author

G. Gennotte

Year

1994

Description

We examine the effect of proportional transaction costs on

dynamic portfolio strategies for an agent who maximizes his

expected utility of terminal wealth. For portfolios composed of

a single risky asset and a single riskless asset, Constantinides

[1979] shows that the optimal investment policy is described in

terms of a no transaction region, where the optimal policy is to

refrain from trading if initial portfolio holdings lie within

the region, and to transact to the nearest boundary of the

region if portfolio holdings lie outside the region. Because

the boundaries could not be derived analytically, we developed

an efficient and tractable algorithm to obtain the boundaries,

which are expressed as the ratio of the dollar holdings in

stocks and bonds. We considered two cases: the same transaction

costs for the two assets, and costs incurred on only the risky

asset. We derived the optimal trading strategies and utility

levels for a large set of realistic parameters. In particular,

we show that the no transaction region narrows and converges

rapidly to the infinite horizon limit as the time horizon

increases.

Complete Citation

Investment Strategies under Transactions Costs: The Finite Horizon Case, co-authored with G. Gennotte. Management Science Journal, March 1994, Vol. 40 No. 3.

Website

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