Parameter Uncertainty in Multiperiod Portfolio Optimization with Transaction Costs

We study the impact of parameter uncertainty on the expected utility of a multiperiod investor subject to quadratic transaction costs. We characterize the utility loss associated with ignoring parameter uncertainty, and show that it is equal to the product between the single-period utility loss and...

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Bibliographic Details
Published inJournal of financial and quantitative analysis Vol. 50; no. 6; pp. 1443 - 1471
Main Authors DeMiguel, Victor, Martín-Utrera, Alberto, Nogales, Francisco J.
Format Journal Article
LanguageEnglish
Published New York, USA Cambridge University Press 01.12.2015
Subjects
Cost estimates
Datasets
Expected utility
Financial portfolios
Investors
Optimization
Portfolios
Quantitative analysis
Risk free assets
Statistical variance
Transaction costs
Uncertainty
Utilities costs
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Summary:We study the impact of parameter uncertainty on the expected utility of a multiperiod investor subject to quadratic transaction costs. We characterize the utility loss associated with ignoring parameter uncertainty, and show that it is equal to the product between the single-period utility loss and another term that captures the effects of the multiperiod mean-variance utility and transaction cost losses. To mitigate the impact of parameter uncertainty, we propose two multiperiod shrinkage portfolios and demonstrate with simulated and empirical data sets that they substantially outperform portfolios that ignore parameter uncertainty, transaction costs, or both.
ISSN:0022-1090
1756-6916
DOI:10.1017/S002210901500054X