Upcoming Conferences

“Multiple Risky Assets, Transaction Costs and Return Predictability: Allocation Rules & Implications for U.S. Investors”

Anthony Lynch, New York University
http://www.stern.nyu.edu/fin/fac/lynch/

Abstract:

Our paper contributes to the dynamic portfolio choice and transaction cost literatures by considering a multiperiod CRRA individual who faces transaction costs and who has access to multiple risky assets, all with predictable returns. We numerically solve the individual’s multiperiod problem in the presence of transaction costs and predictability. Throughout our focus is on the case with two risky assets. With proportional transaction costs and i.i.d. returns, we numerically find the rebalancing rule to be a no-trade region for the portfolio weights with rebalancing to the boundary. With zero correlation, the no-trade region is essentially a rectangle irrespective of the investor’s age. When the correlation of the risky assets is non-zero, the no-trade region becomes essentially a parallelogram. With positive correlation, the parallelogram distorts the associated rectangle in such a way as to take advantage of the associated substitutability across the two assets that the positive correlation induces. The converse is true for negative correlation. Turning to the allocations with return predictability, our numerical results strongly suggest that it is the conditional return correlation over the agent’s likely holding period till her next trade that determines the nature of the distortion to the no-trade parallelogram. We also use our framework to examine a number of important economic questions. To examine the utility cost of redemption fees for rebalancing multiperiod agents, we calibrate the fee rate to data and find that restricting the fee to sales of shares purchased within 6 months, the utility cost of the redemption fee is never more than 0.12% of wealth when returns are i.i.d. and never more than 0.54% of wealth when returns are predictable. We conclude that the utility costs of redemption fees for rebalancing multiperiod investors are small. We find that the utility cost of not being able to buy on margin is much larger that the utility cost of not being able to short, though the “specialness” of stocks, as manifested by a lower rebate rate relative to the T-bill rate, can reduce the utility cost of not being able to short by up to 0.25% of wealth (or up to 19% of the cost of not being able to short) for a ° of 2 and by up to 0.67% of wealth (or up to 30% of the cost of not being able to short) for a ° of 6. Our comparison of the various investment vehicles indicates that using individual stocks for the high and low book-to-market portfolios and ETFs for the market portfolio does better than using ETFs alone or either of the fund families, except when the market portfolio is the only risky asset available (use Vanguard) or when risk aversion is 6 (use ETFs exclusively).