NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Portfolio Choice with Illiquid Assets

Andrew Ang, Dimitris Papanikolaou, Mark Westerfield

NBER Working Paper No. 19436
Issued in September 2013
NBER Program(s):   AP

We present a model of optimal allocation over liquid and illiquid assets, where illiquidity is the restriction that an asset cannot be traded for intervals of uncertain duration. Illiquidity leads to increased and state-dependent risk aversion, and reduces the allocation to both liquid and illiquid risky assets. Uncertainty about the length of the illiquidity interval, as opposed to a deterministic non-trading interval, is a primary determinant of the cost of illiquidity. We allow market liquidity to vary from `normal' periods, when all assets are fully liquid, to 'illiquidity crises,' when some assets can only be traded infrequently. The possibility of a liquidity crisis leads to limited arbitrage in normal times. Investors are willing to forego 2% of their wealth to hedge against illiquidity crises occurring once every ten years.

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Document Object Identifier (DOI): 10.3386/w19436

Published: “Portfolio Choice with Illiquid Assets,” with Dimitris Papanikolaou and Mark M. Westerfield, 2014, Management Science, 60, 11, 2737-2761. citation courtesy of

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