Dynamic Trading with Predictable Returns and Transaction Costs

Nicolae Garleanu, Lasse Heje Pedersen

Research output: Contribution to conferencePaperResearchpeer-review

Abstract

We derive a closed-form optimal dynamic portfolio policy when trading is costly
and security returns are predictable by signals with dierent mean-reversion speeds.The optimal strategy is characterized by two principles: 1) aim in front of the target and 2) trade partially towards the current aim. Specically, the optimal updated portfolio is a linear combination of the existing portfolio and an \aim portfolio," which is a weighted average of the current Markowitz portfolio (the moving target) and the expected Markowitz portfolios on all future dates (where the target is moving). Intuitively, predictors with slower mean reversion (alpha decay) get more weight in the aim portfolio. We implement the optimal strategy for commodity futures and and superior
net returns relative to more naive benchmarks.
Original languageEnglish
Publication date2012
Number of pages58
Publication statusPublished - 2012
EventThe 39th European Finance Association Annual Meeting (EFA 2012) - Copenhagen Business School, Frederiksberg, Denmark
Duration: 15 Aug 201218 Aug 2012
Conference number: 39
http://www.efa2012.org/

Conference

ConferenceThe 39th European Finance Association Annual Meeting (EFA 2012)
Number39
LocationCopenhagen Business School
CountryDenmark
CityFrederiksberg
Period15/08/201218/08/2012
Internet address

Cite this

Garleanu, N., & Heje Pedersen, L. (2012). Dynamic Trading with Predictable Returns and Transaction Costs. Paper presented at The 39th European Finance Association Annual Meeting (EFA 2012), Frederiksberg, Denmark.
Garleanu, Nicolae ; Heje Pedersen, Lasse. / Dynamic Trading with Predictable Returns and Transaction Costs. Paper presented at The 39th European Finance Association Annual Meeting (EFA 2012), Frederiksberg, Denmark.58 p.
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Garleanu, N & Heje Pedersen, L 2012, 'Dynamic Trading with Predictable Returns and Transaction Costs' Paper presented at, Frederiksberg, Denmark, 15/08/2012 - 18/08/2012, .

Dynamic Trading with Predictable Returns and Transaction Costs. / Garleanu, Nicolae ; Heje Pedersen, Lasse.

2012. Paper presented at The 39th European Finance Association Annual Meeting (EFA 2012), Frederiksberg, Denmark.

Research output: Contribution to conferencePaperResearchpeer-review

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AU - Heje Pedersen, Lasse

PY - 2012

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N2 - We derive a closed-form optimal dynamic portfolio policy when trading is costlyand security returns are predictable by signals with dierent mean-reversion speeds.The optimal strategy is characterized by two principles: 1) aim in front of the target and 2) trade partially towards the current aim. Specically, the optimal updated portfolio is a linear combination of the existing portfolio and an \aim portfolio," which is a weighted average of the current Markowitz portfolio (the moving target) and the expected Markowitz portfolios on all future dates (where the target is moving). Intuitively, predictors with slower mean reversion (alpha decay) get more weight in the aim portfolio. We implement the optimal strategy for commodity futures and and superiornet returns relative to more naive benchmarks.

AB - We derive a closed-form optimal dynamic portfolio policy when trading is costlyand security returns are predictable by signals with dierent mean-reversion speeds.The optimal strategy is characterized by two principles: 1) aim in front of the target and 2) trade partially towards the current aim. Specically, the optimal updated portfolio is a linear combination of the existing portfolio and an \aim portfolio," which is a weighted average of the current Markowitz portfolio (the moving target) and the expected Markowitz portfolios on all future dates (where the target is moving). Intuitively, predictors with slower mean reversion (alpha decay) get more weight in the aim portfolio. We implement the optimal strategy for commodity futures and and superiornet returns relative to more naive benchmarks.

M3 - Paper

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Garleanu N, Heje Pedersen L. Dynamic Trading with Predictable Returns and Transaction Costs. 2012. Paper presented at The 39th European Finance Association Annual Meeting (EFA 2012), Frederiksberg, Denmark.