Robust multiperiod portfolio management in the presence of transaction costs

Authors:
Dimitris Bertsimas;Dessislava Pachamanova
Affiliations:
Sloan School of Management and Operations Research Center, Massachusetts Institute of Technology, Building E53-363, Cambridge, MA 02142-1347, USA;Division of Mathematics and Sciences, Babson College, Forest Street, Babson Park, MA 02457, USA
Venue:
Computers and Operations Research
Year:
2008

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Abstract

We study the viability of different robust optimization approaches to multiperiod portfolio selection. Robust optimization models treat future asset returns as uncertain coefficients in an optimization problem, and map the level of risk aversion of the investor to the level of tolerance of the total error in asset return forecasts. We suggest robust optimization formulations of the multiperiod portfolio optimization problem that are linear and computationally efficient. The linearity of the optimization problems is an advantage when complex additional requirements need to be imposed on the portfolio structure, e.g., limitations on positions in certain assets or tax constraints. We compare the performance of our robust formulations to the performance of the traditional single period mean-variance formulation frequently employed in the financial industry.