Optimal trading with transaction costs and short-term predictability

Abstract

We consider the problem of optimal dynamic trading in the presence of predictable returns and proportional transaction costs for an investor choosing among multiple assets. The value of each security equals the expected value of holding the asset plus the value of all options to trade. We provide exact trading rules for N-assets that follow an MA(1) process. Simulations demonstrate the impact of transaction costs, volatility, and predictability on optimal trading behavior. The optimal trading rule can substantially increase performance if transaction costs vary among assets.