Optimal Portfolio Selection with Transaction Costs

Abstract

This paper examines the lifetime portfolio-selection problem in the presence of transaction costs. Using a discrete time approach, we develop analytical expressions for the investor's indirect utility function and also for the boundaries of the no-transactions region. The economy consists of a single risky asset and a riskless asset. Transactions in the risky asset incur proportional transaction costs. The investor has a power utility function and is assumed to maximize expected utility of end-of-period wealth. We illustrate the solution procedure in the case in which the returns on the risky asset follow a multiplicative binomial process. Our paper both complements and extends the recent work by Gennotte and Jung (1994), which used numerical approximations to tackle this problem.     

Optimal design of equity-linked products with a probabilistic constraint

There is a rich variety of tailored investment products available to the retail investor. These products combine upside participation in bull markets with downside protection in bear markets. Examples include the equity-linked products sold by insurance companies and the structured products marketed by banks. This paper examines a particular contract design for products of this nature. The paper finds the optimal design from the investor's viewpoint. It is assumed that the investor wishes to maximize expected utility of the terminal wealth subject to certain constraints. These constraints include a guaranteed rate of return as well as the opportunity to outperform a benchmark portfolio with a given probability. We derive the explicit form of the optimal design assuming both constraints apply and we illustrate the nature of the solution using some specific examples.     

Bill Waters on Schumpeter

Bill Waters’ dissertation “Entrepreneurship, Dualism, and Causality: An Appreciation of the Work of Joseph A. Schumpeter” completed at Georgetown University in 1952 is significant for two reasons. The first is clear enough from the very beginning: Schumpeter and the entrepreneur. The other comes to light through hindsight: Bill brings to bear an understanding of economic affairs which is personalist rather than individualist or collectivist in nature. In short, Bill sees as the main activating force in economic affairs not the impersonal forces of the market, not the central planning board, but the person who innovates, who acts bolding in economic affairs, the banker who creates credit, and the capitalist who supplies old funds. Thus the Waters’ dissertation says much not only about Schumpeter but also about Bill himself. His dissertation is his only book-length publication.     

The duty of the firm in selling to the poor: A question of the person,justice, and subsidiarity

Mainstream economists do not address the question of the duty of the firm in selling to the poor. To them the issue is normative, and they have taken pains to delimit economics as a positive discipline. They separate value and fact, and engage themselves in questions relating to what is and not what should be. Forensic economists hold a different view. Firms are liable for damages due not just to deception and fraud but to negligence as well, and governments have consumer protection agencies to examine cases involving the duty of the firm well beyond deception and fraud. Social economists reject the argument based on libertarianism and individualism that the firm has only one purpose: increasing shareholder value. Social economists view the firm as having several constituencies — shareholders, managers, workers, customers, suppliers, neighbors, partners — and duties associated with each one. Those duties are grounded in the virtue of justice: to render to another that which is owed. The firm has a duty to its customers, its suppliers, and its employees deriving from the principle of equivalence; to its shareholders and employees from the principle of distributive justice; to its competitors and neighbors from the principle of contributive justice. This article argues that the firm has a special duty in selling to the poor which is grounded in the person of the one who is poor, the three principles of economic justice, and the principle of subsidiarity. Mainstream economists address poverty apart from consumer behavior as if the two were unrelated. This article brings the two together and in so doing helps throw light on the question of the duty of the firm in selling to the poor.     

A Contingency Perspective on Psychic Distance in International Channel Relationships

Internationalization theory states that firms, which attempt to forge exchange relationships with foreign counterparts, will be most successful with those who appear to be similar to their own culture and business practices. Other research has pointed toward a psychic distance paradox, whereby successful trading relationships thrive when the parties are “far apart” along these lines (i.e., great psychic distance). These inconsistent findings suggest a contingency approach may better determine when differences between international channel partners are a hindrance to success and when they are an asset. A conceptual model is proposed as to how psychic distance affects an international channel relationship at different stages of its development. In general, it is felt that significant psychic distance will be detrimental to the relationship in its early stages, where it may serve as an asset in later stages of the relationship.     

Payback without apology

When interest rates are uncertain, the net‐present‐value threshold required to justify an irreversible investment is increasing in the length of a project's payback period. Therefore, slow‐payback projects should face a higher hurdle than fast‐payback projects, just as investment folklore suggests. This result suggests that the widely disparaged use of payback for capital budgeting purposes can be an intuitive response to correctly perceived costs and benefits.