I got a problem when calculating the out-of-sample performance of my model. I have the following settings:
I have daily data.
I use a rolling window of 1 week.
I use the previous six months of data to estimate my model parameters.
Thus, the model parameters are estimated every week using the previous 6 month of data. Each time the parameters are estimated the investment control remains fixed for 1 week (I do not rebalance) until the parameters are next updated.
My question is: How do I calculate performance/return including transaction cost? When I have estimated the parameters and make a trade to rebalance at day 1, do I then need to
Calculate the daily return of the portfolio in the 1 week window and sum it to get the return for the week.
Compute the new positions from the new estimated parameters.
Compute the total expected trading cost from step 2).
Subtract the total expected trading cost from the portfolio return calculated in 1.