Mean Reversion Pays, but Cost
A mean-reverting ﬁnancial instrument is optimally traded by buying it when it is suﬃciently below the estimated ‘mean level’ and selling it when it is above. In the presence of linear transaction costs, a large amount of value is paid away crossing bid-oﬀers unless one devises a ‘buﬀer’ through which the price must move before a trade is done. In this paper, Richard Martin and Torsten Schoneborn derive the optimal strategy and conclude that for low costs the buﬀer width is proportional to the cube root of the transaction cost, determining the proportionality constant explicitly.
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