Discrete-Time Implementationof Continuous-Time Portfolio Strategies

Since trading cannot take place continuously, the optimal portfolio calculated ina continuous-time model cannot be held, but the investor has to implement thecontinuous-time strategy in discrete time. This leads to the question how severe theresulting discretization error is. We analyze this question in a simulation study fora variety of models. First, we show that discrete trading can be neglected if onlythe stock and the money market account are traded, even in models with additionalrisk factors like stochastic volatility and jump risk in the stock and in volatility.Second, we show that the opposite is true if derivatives are traded. In this case, theutility loss due to discrete trading may be much larger than the utility gain fromhaving access to derivatives. To profit from trading derivatives, the investor has torebalance his portfolio at least every day.