THE MEAN-VARIANCE APPROACH TO PORTFOLIO OPTIMIZATION SUBJECT TO TRANSACTION COSTS

Tra,nsact>ion costss are a. source of concern for port,folio managers. Due to nonlinearity of the cost function, the ordinary quadratic programming solution technique cannot be applied. This paper addresses the portfolio optinlization problem subject to transaction costs. The transaction cost is assumed to be a V-sha,ped function of difference between an existing and new portfolio. A nonlinear programming solution technique is used to solve t,he proposed problem. The port,folio optimiza,t,ion syst,em ca,lled POSTRAC (Portfolio Optirniza,tion System with TRAnsaction Costs) is proposed. The experimental analysis indicates that ignoring the transa,ction costss results in inefficient portfolios. It is also shown tlmt there does not exist statistica,lly significant difference in portfolio performance with different methods to estimate the expected return of se~urit~ies, when considering the tra,nsact,ion costs int,o the p~rt~folio return.