  We theoretically and empirically study portfolio optimization under
transaction costs and establish a link between turnover penalization and
covariance shrinkage with the penalization governed by transaction costs. We
show how the ex ante incorporation of transaction costs shifts optimal
portfolios towards regularized versions of efficient allocations. The
regulatory effect of transaction costs is studied in an econometric setting
incorporating parameter uncertainty and optimally combining predictive
distributions resulting from high-frequency and low-frequency data. In an
extensive empirical study, we illustrate that turnover penalization is more
effective than commonly employed shrinkage methods and is crucial in order to
construct empirically well-performing portfolios.
