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Multiple Risky Assets, Transaction Costs, and Return Predictability: Allocation Rules and Implications for U.S. Investors

Published online by Cambridge University Press:  02 July 2010

Anthony W. Lynch  and
Sinan Tan
Anthony W. Lynch
Affiliation:
Stern School of Business, New York University, 44 W. 4th St., Ste. 9-190, New York, NY 10012, and NBER. alynch@stern.nyu.edu
Sinan Tan
Affiliation:
Graduate School of Business Administration, Fordham University, 113 W. 60th St., Ste. 403B, New York, NY 10023.tan@fordham.edu
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Abstract

This paper numerically solves the decision problem of a multiperiod constant relative risk aversion individual who faces transaction costs and has access to two risky assets, both with predictable returns. With proportional transaction costs and independent and identically distributed returns, we numerically find the rebalancing rule to be a no-trade region for the portfolio weights with rebalancing to the boundary. The shape of the no-trade region depends on the correlation between the two risky assets. With predictable returns, there is instead a no-trade region for each state. We also examine several important economic questions, including the utility cost of not being able to buy on margin or short stock.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 4 , August 2010 , pp. 1015 - 1053
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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