Optimal market timing strategies under transaction costs

Wei Li*, Kin Lam

*Corresponding author for this work

    Research output: Contribution to journalJournal articlepeer-review

    6 Citations (Scopus)


    In this paper, we consider optimal market timing strategies under transaction costs. We assume that the asset's return follows an auto-regressive model and use long-term investment growth as the objective of a market timing strategy which entails the shifting of funds between a risky asset and a riskless asset. We give the optimal trading strategy for a finite investment horizon, and analyze its limiting behavior. For a finite horizon, the optimal decision in each step depends on two threshold values. If the return today is between the two values, nothing needs to be done, otherwise funds will be shifted from one asset to another, depending on which threshold value is being exceeded. When investment horizon tends to infinity, the optimal strategy converges to a stationary policy, which is shown to be closely related to a well-known technical trading rule, called Momentum Index trading rule. An integral equation of the two threshold values is given. Numerical results for the limiting stationary strategy are presented. The results confirm the obvious guess that the no-transaction region increases as the transaction cost increase. Finally, the limiting stationary strategy is applied to data in the Hang Seng Index Futures market in Hong Kong. The out-of-sample performance of the limiting stationary strategy is found to be better than the simple strategy used in literature, which is based on an 1-step ahead forecast of return.

    Original languageEnglish
    Pages (from-to)97-108
    Number of pages12
    Issue number2
    Publication statusPublished - Apr 2002

    Scopus Subject Areas

    • Strategy and Management
    • Management Science and Operations Research
    • Information Systems and Management

    User-Defined Keywords

    • Market timing
    • Autoregressive models
    • Growth-optimal investment strategy
    • Stochastic dynamic programming


    Dive into the research topics of 'Optimal market timing strategies under transaction costs'. Together they form a unique fingerprint.

    Cite this