2021/10/07 by Isichenko, Michael
#FOS: Economics and business #Portfolio Management (q-fin.PM) #Trading and Market Microstructure (q-fin.TR)
paper · doi:10.48550/arxiv.2110.15239
We revisit optimal execution of an active portfolio in the presence of slippage (aka linear, proportional, or absolute-value) costs. Market efficiency implies a close balance between active alphas and trading costs, so even small changes to trading optimization can make a big difference. It has been observed for some time that optimal trading involves a pattern of a no-trade zone with width Δ increasing with slippage cost parameter c. In a setting of a reasonably stable (non-stochastic) forecast of future returns and a quadratic risk aversion, it is shown that Δ∼ c1/2, which differs from the Δ∼ c1/3 scaling reported for stochastic settings. Analysis of optimal trading employs maximization of a utility including projected alpha-based profits, slippage costs, and risk aversion and borrows from a physical analogy of forced motion in the presence of friction.