Parameter uncertainty in multiperiod portfolio optimization with transaction costs

DeMiguel, V, Martín-Utrera, A and Nogales, F J (2015) Parameter uncertainty in multiperiod portfolio optimization with transaction costs. Journal of Financial and Quantitative Analysis, 50 (06). pp. 1443-1471. ISSN 0022-1090

Abstract

We study the impact of parameter uncertainty on the expected utility of a multiperiod investor subject to quadratic transaction costs. We characterize the utility loss associated with ignoring parameter uncertainty, and show that it is equal to the product between the single-period utility loss and another term that captures the effects of the multiperiod mean-variance utility and transaction cost losses. To mitigate the impact of parameter uncertainty, we propose two multiperiod shrinkage portfolios and demonstrate with simulated
and empirical data sets that they substantially outperform portfolios that ignore parameter uncertainty, transaction costs, or both.