Parameter uncertainty in multiperiod portfolio optimization with transaction costs Articles uri icon

publication date

  • December 2015

start page

  • 1443

end page

  • 1471

issue

  • 6

volume

  • 50

international standard serial number (ISSN)

  • 0022-1090

electronic international standard serial number (EISSN)

  • 1756-6916

abstract

  • We study the impact of parameter uncertainty on the expected utility of a multiperiod investorsubject to quadratic transaction costs. We characterize the utility loss associatedwith ignoring parameter uncertainty, and show that it is equal to the product betweenthe single-period utility loss and another term that captures the effects of the multiperiodmean-variance utility and transaction cost losses. To mitigate the impact of parameter uncertainty,we propose two multiperiod shrinkage portfolios and demonstrate with simulatedand empirical data sets that they substantially outperform portfolios that ignore parameteruncertainty, transaction costs, or both.