A simple algorithm to incorporate transactions costs in quadratic optimisation

A simple algorithm to incorporate transactions costs in quadratic optimisation

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Article ID: iaor1998806
Country: Netherlands
Volume: 79
Issue: 1
Start Page Number: 85
End Page Number: 94
Publication Date: Nov 1994
Journal: European Journal of Operational Research
Authors: ,
Keywords: investment, programming: quadratic
Abstract:

Quantitative fund management invariably involves portfolio performance being measured in terms of a quadratic objective function (due to the inclusion of variance terms as a measure of risk). Periodically, the constituents of the fund are adjusted to improve performance. This adjustment incurs a transaction cost which is a modulus function of the changes in holdings. Thus the fund manager wishes to minimise a combined quadratic and modulus function. This paper presents a new approach to deal with the minimisation of this hybrid function, using a well tried quadratic programming algorithm. The new algorithm is demonstrated using a tactical asset allocation problem and an equity index tracking fund.

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