Dynamic Asset Allocation with Predictable Returns and Transaction Costs

Download or read book Dynamic Asset Allocation with Predictable Returns and Transaction Costs written by Pierre Collin-Dufresne and published by . This book was released on 2015 with total page 57 pages. Available in PDF, EPUB and Kindle. Book excerpt: We propose a simple approach to dynamic multi-period portfolio choice with transaction costs that is tractable in settings with a large number of securities, realistic return dynamics with multiple risk factors, many predictor variables, and stochastic volatility. We obtain a closed-form solution for an optimal trading rule when the problem is restricted to a broad class of strategies we define as 'linearity generating strategies' (LGS). When restricted to this class, the non-linear dynamic optimization problem reduces to a deterministic linear-quadratic optimization problem in the parameters of the trading strategies. We show that the LGS approach dominates several alternatives in realistic settings, and in particular when the covariance structure and transaction costs are stochastic.