Predictability and transaction costs: The impact on rebalancing rules and behavior

Recent papers show that predictability calibrated to U.S. data has a large effect on the rebalancing behavior of a multiperiod investor. We find that this continues to he true in the presence of realistic transaction costs. I n particular, predictability causes the no-trade region for the risky-asset holding to become state dependent and, on average, wider and higher. Predi ctability also motivates the investor to spend considerably more on rebalan cing and to rebalance more often. In other results, we find that introducin g costly liquidation of the risky asset for consumption lowers the average allocation to the risky asset, though only marginally early in life. Our ex periments also vary the nature of the return predictability and introduce r eturn heteroskedasticity.