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Portfolio Theory and Management$
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H. Kent Baker and Greg Filbeck

Print publication date: 2013

Print ISBN-13: 9780199829699

Published to Oxford Scholarship Online: May 2013

DOI: 10.1093/acprof:oso/9780199829699.001.0001

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Trading Strategies, Portfolio Monitoring, and Rebalancing

Trading Strategies, Portfolio Monitoring, and Rebalancing

(p.383) 17 Trading Strategies, Portfolio Monitoring, and Rebalancing
Portfolio Theory and Management

Riccardo Cesari

Massimiliano Marzo

Oxford University Press

Trading strategies translate goals and constraints of asset management into dynamic, intertemporal, and coherent portfolio decisions. Under special assumptions, myopic portfolio policies are shown to be optimal and constant over time. In general, however, both optimal theoretical portfolios and current portfolio positions are subject to random movements so that periodic monitoring and rebalancing are necessary. Transaction and monitoring costs create a tradeoff between the cost of not being at the optimal allocation (tracking error) and the cost of swapping the current portfolio for the optimal one. Optimal rebalancing results in the replacement of the optimal allocation with a no-trade region delimited by rebalance boundaries. The factors influencing the boundaries and the rebalancing decisions can be analytically and numerically explained. Popular rebalancing rules imply a substantial amount of excess trading costs, but they can generate positive net returns in the case of mean-reverting market regimes.

Keywords:   trading strategies, asset management, intertemporal, monitoring, rebalancing, trading costs

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