Optimal portfolios under transaction costs in discrete time markets

Abstract

We study portfolio investment problem from a probabilistic modeling perspective and study how an investor should distribute wealth over two assets in order to maximize the cumulative wealth. We construct portfolios that provide the optimal growth in i.i.d. discrete time two-asset markets under proportional transaction costs. As the market model, we consider arbitrary discrete distributions on the price relative vectors. To achieve optimal growth, we use threshold portfolios. We demonstrate that under the threshold rebalancing framework, the achievable set of portfolios elegantly form an irreducible Markov chain under mild technical conditions. We evaluate the corresponding stationary distribution of this Markov chain, which provides a natural and efficient method to calculate the cumulative expected wealth. Subsequently, the corresponding parameters are optimized using a brute force approach yielding the growth optimal portfolio under proportional transaction costs in i.i.d. discrete-time two-asset markets.