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Parameter Uncertainty in Multiperiod Portfolio Optimization with Transaction Costs

Published online by Cambridge University Press:  20 January 2016

Victor DeMiguel ,
Alberto Martín-Utrera  and
Francisco J. Nogales
Victor DeMiguel
Affiliation:
[email protected], London Business School, London NW1 4SA, United Kingdom
Alberto Martín-Utrera*
Affiliation:
[email protected], Lancaster University Management School, Lancaster LA1 4YX, United Kingdom
Francisco J. Nogales
Affiliation:
[email protected], Universidad Carlos III de Madrid, Getafe (Madrid) 28903, Spain.
*
*Corresponding author: [email protected]
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Abstract

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.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 50 , Issue 6 , December 2015 , pp. 1443 - 1471
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

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