Optimal two-parameter portfolio management strategy with transaction costs

Chutian Ma; Paul Smith

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arXiv · 2411.07949

Optimal two-parameter portfolio management strategy with transaction costs

Chutian Ma·Paul Smith

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Abstract

We consider a simplified model for optimizing a single-asset portfolio in the presence of transaction costs given a signal with a certain autocorrelation and cross-correlation structure. In our setup, the portfolio manager is given two one-parameter controls to influence the construction of the portfolio. The first is a linear filtering parameter that may increase or decrease the level of autocorrelation in the signal. The second is a numerical threshold that determines a symmetric "no-trade" zone. Portfolio positions are constrained to a single unit long or a single unit short. These constraints allow us to focus on the interplay between the signal filtering mechanism and the hysteresis introduced by the "no-trade" zone. We then formulate an optimization problem where we aim to minimize the frequency of trades subject to a fixed return level of the portfolio. We show that maintaining a no-trade zone while removing autocorrelation entirely from the signal yields a locally optimal solution. For any given "no-trade" zone threshold, this locally optimal solution also achieves the maximum attainable return level, and we derive a quantitative lower bound for the amount of improvement in terms of the given threshold and the amount of autocorrelation removed.

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Chutian Ma, Paul Smith. 2024-11-12. Optimal two-parameter portfolio management strategy with transaction costs. https://arxiv.org/abs/2411.07949

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