Transaction Costs and Integer Constraints
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In this chapter, a model for portfolio selection under fixed and/or proportional transaction costs together with non-negativity and integer constraints was presented and empirically studied on basis of DAX data. The major results from this study are that the presence of transaction costs might lead to significantly different results than for a perfect market and that the types of costs the investor occurs have different effects. Also, the optimal solution under transaction costs can not always be derived from the solution for frictionless markets.
Introducing transaction costs might have severe effects on the optimal portfolio structure. Even low fixed costs can lead to a substantial reduction in the number of different assets that ought to be included in a portfolio; the same is true for proportional costs or compound cost schemes. In due course, the asset weights might differ substantially. An investor facing transaction costs might therefore even have distinct advantages from individual stock selection over investing into a market fund — provided she does not simply try to replicate its weights but includes the relevant costs and additional constraints into the optimization process. Unlike claimed for a perfect market situation, in real world it might therefore be reasonable to hold a portfolio that deviates from the market portfolio even when all investors have homogeneous expectations. Another conclusion from these results is that investors might have advantages when they can invest in funds that are not just tracking the market portfolio, but also anticipate their clients’ transaction costs.
KeywordsTransaction Cost Portfolio Selection Sharpe Ratio Initial Endowment Portfolio Weight
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