Finite Horizon Portfolio Selection

Abstract

We study the problem of maximising expected utility of terminal wealth over a nite horizon, with one risky and one riskless asset available, and with trades in the risky asset subject to proportional transaction costs. In a discrete time setting, using a utility function with hyperbolic risk aversion, we prove that the optimal trading strategy is characterised by a function of time (t), which represents the ratio of wealth held in the risky asset to that held in the riskless asset. There is a time varying no transaction region with boundaries b(t) < s(t), such that the portfo- lio is only rebalanced when (t) is outside this region. The results are consistent with similar studies of the in nite horizon problem with in- termediate consumption, where the no transaction region has a similar, but time independent, characterisation. We solve the problem numerically and compute the boundaries of the no transaction region for typical model parameters. We show how the results ...