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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/27341
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| Title: | Multiple Risky Assets, Transaction Costs and Return Predictability:
Implications for Portfolio Choice |
| Authors: | Lynch, Anthony W.
Tan, Sinan |
| Issue Date: | 17-Dec-2002 |
| Series/Report no.: | S-MF-02-11 |
| Abstract: | Our paper contributes to the dynamic portfolio choice and transaction
cost literatures by considering a multiperiod CRRA individual who faces
transaction costs and who has access to multiple risky assets, all with
predictable returns. We numerically solve the individual’s
multiperiod problem in the presence of transaction costs and
predictability. In particular, we characterize the investor’s
optimal portfolio choice with proportional and fixed transaction costs,
and with return predictability similar to that observed for the U.S.
stock market. We also perform some comparative statistics to better
understand the nature of the no-trade region with more than one risky
asset. Throughout our focus is on the case with two risky assets. We
also perform some utility comparisons. The calibration exercise reveals
some interesting results about the relative attractiveness of the three
equity portfolios calibrated. With proportional transaction costs and
i.i.d. returns, we numerically find the rebalancing rule to be a
no-trade region for the portfolio weights with rebalancing to the
boundary. With zero correlation, the no-trade region is a rectangle
irrespective of the investor’s age. When the correlation of the
risky assets is non-zero, the no-trade region becomes a parallelogram.
With positive correlation, the parallelogram distorts the associated
rectangle in such a way as to take advantage of the associated
substitutability across the two assets that the positive correlation
induces. The converse is true for negative correlation. Turning to the
allocations with return predictability, our numerical results strongly
suggest that it is the conditional return correlation that determines
the nature of the distortion to the no-trade parallelogram. Irrespective
of the investor’s age, the distortion always mirrors the no-trade
parallelogram distortion that we find in the i.i.d. case for return
correlation of the same sign. The no-trade region is always larger late
in life than early in life. However, the difference in no-trade area
between early and late in life is less pronounced when returns are
predictable, consistent with intuition that the benefits from
rebalancing today are more short-lived when returns are predictable than
in the i.i.d. case. |
| URI: | http://hdl.handle.net/2451/27341 |
| Appears in Collections: | Macro Finance
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