This paper develops a portfolio model that reflects investors’ aversion to turnover. This is done by penalizing the deviation from a reference portfolio. Turnover aversion renders a robust portfolio that performs superior under parameter uncertainty. It also improves the performance of shrinkage portfolio models that are sub-optimal due to model parameter uncertainty. The equal-weight portfolio serves better as the reference portfolio than the current portfolio even in the presence of transaction costs. The degree of turnover aversion required for the minimum utility loss can be strikingly high. A comprehensive empirical study suggests that the proposed model outperforms various existing models.

JEL Classification: G11

Keywords: Optimal portfolio; Turnover aversion; Shrinkage estimator; Parameter uncertainty; Estimation error; Transaction cost