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Risks 2015, 3(3), 318-337;

Delivering Left-Skewed Portfolio Payoff Distributions in the Presence of Transaction Costs

Victoria University of Wellington, School of Economics and Finance, PO Box 600, Wellington 6140, New Zealand
This paper is an extended version of a paper under the same title presented by the author at the Quantitative Methods in Finance 2013 Conference, Sydney, Australia. It was further revised while the author was a visiting scholar at the Department of Mathematics at Macquarie University, Sydney, NSW 2109.
Academic Editor: Andrea Consiglio
Received: 10 January 2015 / Accepted: 11 August 2015 / Published: 21 August 2015
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For pension-savers, a low payoff is a financial disaster. Such investors will most likely prefer left-skewed payoff distributions over right-skewed payoff distributions. We explore how such distributions can be delivered. Cautious-relaxed utility measures are cautious in ensuring that payoffs don’t fall much below a reference value, but relaxed about exceeding it. We find that the payoff distribution delivered by a cautious-relaxed utility measure has appealing features which payoff distributions delivered by traditional utility functions don’t. In particular, cautious-relaxed distributions can have the mass concentrated on the left, hence be left-skewed. However, cautious-relaxed strategies prescribe frequent portfolio adjustments which may be expensive if transaction costs are charged. In contrast, more traditional strategies can be time-invariant. Thus we investigate the impact of transaction costs on the appeal of cautious-relaxed strategies. We find that relatively high transaction fees are required for the cautious-relaxed strategy to lose its appeal. This paper contributes to the literature which compares utility measures by the payoff distributions they produce and finds that a cautious-relaxed utility measure will deliver payoffs that many investors will prefer. View Full-Text
Keywords: portfolio management; payoff distributions; pension funds; transaction costs portfolio management; payoff distributions; pension funds; transaction costs

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This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited (CC BY 4.0).

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Krawczyk, J.B. Delivering Left-Skewed Portfolio Payoff Distributions in the Presence of Transaction Costs. Risks 2015, 3, 318-337.

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