Dynamic portfolio optimization with transaction costs and state-dependent drift

Abstract

We present an efficient numerical method to determine optimal portfolio strategies under time- and state-dependent drift and proportional transaction costs. This scenario arises when investors have behavioral biases or the actual drift is unknown and needs to be estimated. The numerical method solves dynamic optimal portfolio problems for time-horizons of up to 40 years. It is applied to measure the value of information and the loss from transaction costs using the indifference principle.