February 10th, 2004, 10:30 am
The question is a little bit more complicated due to the fact that it concerns modelling transaction costs with software where the decision taken by the software system whether to recommend trade in certian position/portfolio depends on the transaction costs that might be incurred. Thus the aim of the optimization is to maximize return given particular risk threshold level. However, the nature of transaction costs (depending on traded volume and/or the type of the traded financial instrument) affects directly return and the decisions taken by the system. An easy way to solve the problem is to offer software users the option to enter average transaction costs per trade (let's say expressed in percentage terms) as a setting in the software interface. However, the latter option renders difficulties for the user himself. I believe that the issue could be solved in a more elegant manner. Any suggestions and past experience with such problems are more than welcome.