Discrete-time mean-variance portfolio selection with transaction costs

Abstract

Transaction cost is a realistic feature in financial markets. This thesis incorporates proportional transaction costs into the mean-variance formulation, and studies the optimal asset allocation policy in two kinds of single-period markets. The optimal asset allocation strategy is completely characterized in the market consisting of one riskless asset and one risky asset. Analytical expression for the optimal portfolio is derived, and the so-called "burn-money" phenomenon is observed. In the market consisting of one riskless asset and two risky assets, we provide a detailed scheme to obtain the optimal portfolio. We also study the no-transaction region and some special asset allocation strategies in this market.