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Models for Portfolio Revision with Transaction Costs in the Mean–Variance Framework

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Handbook of Portfolio Construction

Abstract

The contribution of the mean–variance framework by Markowitz more than a half century ago cannot be understated. Since that time, the framework has been extended in several ways. One extension has been to consider the practical application of the framework when an existing portfolio of securities must be revised by changing the composition of the portfolio rather than the initial deployment of cash to construct a portfolio. Since then there have been several proposals for modeling portfolio revision with transaction costs within the mean–variance framework. This chapter summarizes these proposals and presents one recently formulated model and some empirical evidence. More specifically, we consider the portfolio revision problem with transaction costs that are paid at the end of the planning horizon, and present some analytical solutions for some special cases in the mean–variance framework. Moveover, a simple empirical experiment with actual market data shows that the impact of the transaction costs is significant, confirming the findings of Chen et al. (1971) that transaction costs should be integrated into the portfolio revision optimization problem, and that lower revision frequency may reduce the magnitude of the impact.

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Author information

Authors and Affiliations

  1. Edwin L. Cox School of Business, Southern Methodist University, Dallas, TX, USA

    Andrew H. Chen

  2. Yale School of Management, New Haven, CT, USA

    Frank J. Fabozzi

  3. Olin School of Business, Washington University, St. Louis, MO, USA

    Dashan Huang

Authors
  1. Andrew H. Chen
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  2. Frank J. Fabozzi
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  3. Dashan Huang
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Corresponding author

Correspondence to Frank J. Fabozzi .

Editor information

Editors and Affiliations

  1. McKinley Capital Management, LLC, 3301 C. Street, Anchorage, AK, 99503, USA

    John B. Guerard Jr.

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Chen, A.H., Fabozzi, F.J., Huang, D. (2010). Models for Portfolio Revision with Transaction Costs in the Mean–Variance Framework. In: Guerard, J.B. (eds) Handbook of Portfolio Construction. Springer, Boston, MA. https://doi.org/10.1007/978-0-387-77439-8_6

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