Portfolio Choice with Illiquid Assets
Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)
Northwestern University - Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER)
Mark M. Westerfield
University of Washington
October 24, 2010
Netspar Discussion Paper No. 10/2010-092
We solve for optimal asset allocation and consumption policies for long-lived constant relative risk averse (CRRA) investors holding both liquid and illiquid assets. Liquid assets can be rebalanced continuously, whereas illiquid assets can only be traded at infrequent, stochastic intervals. By creating an unhedgeable source of risk, illiquidity induces additional time-varying risk aversion above the constant utility coefficient of risk aversion. Illiquidity risk affects the asset allocation of both liquid and illiquid securities and causes optimal consumption and portfolio policies to depend on the mix of illiquid and liquid assets in the investor’s portfolio. Illiquidity effects are observed even for log utility investors and when liquid and illiquid asset returns are uncorrelated.
Number of Pages in PDF File: 50
Keywords: asset allocation, liquidity, alternative assets, endowment model
JEL Classification: G11, G12working papers series
Date posted: April 22, 2011
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