A Mean-Variance Model for Optimal Portfolio Selection with Transaction Costs

Abstract

On the basis of Markowitz mean-variance framework, a new optimal portfolio selection approach is presented. The portfolio selection model proposed in the approach includes the expected return, the risk, and especially a quadratic type transaction cost of a portfolio. Using this model may yield an optimal portfolio solution that maximizes return, and minimizes risk, as well as also minimizes transaction costs by softening the transaction strength and smoothing the volume of the transacted securities in trading process. The optimization problem appeared in this approach is convex and can be solved by the quadratic programming (QP) routine. A case study demonstrates the effectiveness and the significant performance improvements of the optimal portfolio selection strategy proposed.