Portfolio selection with transaction costs under expected shortfall constraints

Abstract

An investor subject to proportional transaction costs allocates funds to multiple stocks and a bank account, to maximise the expected growth rate of the portfolio value under Expected Shortfall (ES) constraints. In a numerical example with ten time steps and one stock important innovations are caused by the introduction of the Expected Shortfall constraint: First, expected returns are reduced by less than one-tenth when the ES constraint is introduced. In comparison, economic capital as measured by ES, is reduced to amounts between one-half and three-quarters, when the ES constraint is introduced. Second, the dependence of expected return and ES on the initial portfolio, in particular when transaction costs are high, is largely removed by the introduction of the ES constraint.