We derive a closed-form optimal dynamic portfolio policy when trading is costly and security returns are predictable by signals with dierent mean-reversion speeds.The optimal strategy is characterized by two principles: 1) aim in front of the target and 2) trade partially towards the current aim. Specically, the optimal updated portfolio is a linear combination of the existing portfolio and an \aim portfolio," which is a weighted average of the current Markowitz portfolio (the moving target) and the expected Markowitz portfolios on all future dates (where the target is moving). Intuitively, predictors with slower mean reversion (alpha decay) get more weight in the aim portfolio. We implement the optimal strategy for commodity futures and and superior net returns relative to more naive benchmarks.
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The 39th European Finance Association Annual Meeting (EFA 2012)