DeMiguel, Victor and Martin Utrera, Alberto and Nogales, Francisco J. (2015) Parameter uncertainty in multiperiod portfolio optimization with transaction costs. Journal of Financial and Quantitative Analysis, 50 (6). pp. 1443-1471. ISSN 0022-1090
DMN_2015_11_04.pdf - Accepted Version
Download (408kB)
Abstract
We study the impact of parameter uncertainty in the expected utility of a multiperiod investor subject to quadratic transaction costs. We characterize the utility loss associated with ignoring parameter uncertainty, and show that it is equal to the product between the single-period utility loss and another term that captures the effects of the multiperiod mean-variance utility and transaction cost losses. To mitigate the impact of parameter uncertainty, we propose two multiperiod shrinkage portfolios and demonstrate with simulated and empirical datasets that they substantially outperform portfolios that ignore parameter uncertainty, transaction costs, or both.