Abstract
The performance of online (sequential) portfolio selection (OPS), which rebalances a portfolio in every period (e.g. daily or weekly) in order to maximise the portfolio's expected terminal wealth in the long run, has been overestimated by the ideal assumption of unlimited market liquidity (i.e. no market impact costs). Therefore, a new transaction cost factor model that considers market impact costs, estimated from limit order book data, as well as proportional transaction costs (e.g. brokerage commissions or transaction taxes in a fixed percentage) is proposed in this paper for both measuring OPS performance in a more practical way and developing a new OPS method. Backtesting results from the historical limit order book data of NASDAQ-traded stocks show both the performance deterioration of OPS by the market impact costs and the superiority of the proposed OPS method in the environment of limited market liquidity. MATLAB codes are available at http://www.mathworks.com/matlabcentral/fileexchange/56496.
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