Balancing small fixed and proportional transaction cost in trading strategies

Transaction costs appear in financial markets in more than one form. There are several results in the literature on small proportional transaction cost and not that many on fixed transaction cost. In the present work, we heuristically study the effect of both types of transaction cost by focusing on a portfolio optimization. Here we assume the presence of fixed transaction cost and that there is a balance between fixed and proportional transaction cost, such that none of them dominates the other, asymptotically. We find out that the deviation of value function, when the fixed transaction cost is $\varepsilon$, from the Merton value function, without transaction cost, is of order $\varepsilon^1/2$ which is different from the pure proportional cost of $\varepsilon^2/3$. Based on this, we propose an expansion for the value function in terms of powers of $\varepsilon^1/2$.

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