The Impact of Transaction Costs in Portfolio Optimization: A Comparative Analysis between the Cost of Trading in Peru and the United States

By Chavalle, Luc; Chavez-Bedoya, Luis | Journal of Economics, Finance and Administrative Science, July-December 2019 | Go to article overview

The Impact of Transaction Costs in Portfolio Optimization: A Comparative Analysis between the Cost of Trading in Peru and the United States


Chavalle, Luc, Chavez-Bedoya, Luis, Journal of Economics, Finance and Administrative Science


1. Introduction

The Peruvian stock exchange, known as the Bolsa de Valores de Lima (BVL), currently lists 278 securities with a total market capitalization of about US$130bn[1]. It is regulated by the Superintendencia del Mercado de Valores and has a limited exchange self-regulatory organization. The BVL is currently facing serious liquidity and low transaction volume problems[2], and its average daily trading volume in 2016 was US$18.26m. On the other hand, the New York Stock Exchange (NYSE) is the biggest stock market in the world with a market capitalization of nearly US$20.6tn[3]. It is regulated by the Securities and Exchange Commission (SEC). The NYSE is characterized by its high liquidity and its large stock inflows and outflows that incur on a daily basis, around US$42bn are traded every day and has more than 2,700 listed firms. The Sustainable Stock Exchange Initiative considers the NYSE as one of the most advanced stock exchanges in the world. Because of its quality standards, the NYSE has been selected as a benchmark to compare transaction costs (TC) with the ones of the BVL.

We define TC as the cost of buying or selling securities to rebalance or build a particular portfolio. The TC structure in Peru is interesting in the sense that it charges investors a percentage of the stock value traded. However, there is also a minimum trading fee to pay that is high and finally makes the Peruvian stock market very expensive with respect to the ones of more developed markets. In the USA, there exist two types of TC. The first one charges investors per the number of shares they buy or sell, and it is called TC per share. The second structure charges investors per the number of trades they make, and it is called TC per trade. The comparison of the aforementioned TC structures with the one applied in Peru (TC per percentage) is used to determine which type of TC is the most appropriate and under which conditions this said type could happen.

To answer the previous research question, we analyze the behavior of the TC structures in Peru and the USA over three dimensions: the type and number of stocks, the holding period of the portfolio and the selected trading strategy. The paper concludes that TC per share is the cheapest when small monetary amounts are invested in the portfolio, but once a certain initial amount is reached, TC per trade becomes preferable. However, the TC structure applied in Peru represents the most expensive structure for any dimension. This analysis was carried on using current cost parameters found in both the BVL and the NYSE. To the best of our knowledge, there has not been any study analyzing the cost of trading in Peru and assessing the convenience of the TC structure applied on the BVL. Also, as a byproduct of our analysis, we corroborate some empirical regularities like that TC are higher for portfolios composed of small market capitalizations stocks, holding period helps dilute entry and exit costs and active trading strategies are subject to higher TC[4].

In conclusion, retail investors that decide to invest in the Peruvian stock market can only do so if they adopt a buy and hold investment strategy. In fact, they would be facing substantial TC by rebalancing their portfolio from month to month. This is more dramatic for small initial investment amounts. For example, if US$30K are invested in Peruvian stocks (under TC per percentage), the investor can lose up to 10 per cent in yearly return owing to TC. In comparison, trading the same stocks in the USA under the other TC structures incurs 1 per cent in yearly return. The main issue is that the minimum trading fee applied in Peru is very expensive compared with the stock inflows and outflows that are actually incurred. Therefore, portfolio rebalancing and active portfolio management strategies could be adopted in the BVL only if the minimum trading fee was at least the same as the one applied for TC per share in the USA. To make the Peruvian TC per percentage competitive, a dramatic reduction in the minimum cost per trade is needed: it has to go from $25 to $1 to make the current cost structure competitive for a retail investor with a relatively small initial investment amount. …

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