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Optimal Consumption and Investment with Transaction Costs and Multiple Risky Assets


  • Hong Liu

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    • Liu is from the John M. Olin School of Business, Washington University in St. Louis. I thank Domenico Cuoco, Sanjiv Das, Phil Dybvig, Bob Goldstein, Zhongfei Li, Mark Loewenstein, Mark Schroder, Dimitri Vayanos, Guofu Zhou, and participants in the 2002 WFA Conference, the 2002 International Finance Conference, the 2001 International Mathematical Finance Conference, and the University of Kentucky seminar for helpful comments. I am especially indebted to an anonymous referee, Rick Green (the Editor) and Kerry Back for very useful suggestions. Any remaining errors are of course mine.


We consider the optimal intertemporal consumption and investment policy of a constant absolute risk aversion (CARA) investor who faces fixed and proportional transaction costs when trading multiple risky assets. We show that when asset returns are uncorrelated, the optimal investment policy is to keep the dollar amount invested in each risky asset between two constant levels and upon reaching either of these thresholds, to trade to the corresponding optimal targets. An extensive analysis suggests that transaction cost is an important factor in affecting trading volume and that it can significantly diminish the importance of stock return predictability as reported in the literature.

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