Liquidity-Driven Dynamic Asset Allocation

James X. Xiong

Ibbotson Associates

Rodney N Sullivan

AQR Capital Management

Peng Wang

University of Virginia - Investment Management Company

August 28, 2012

Journal of Portfolio Management, Forthcoming

We propose a model of portfolio selection that adjusts an investors’ portfolio allocation in accordance with changing market liquidity environments and market conditions. We found that market liquidity provides a useful “leading indicator” in dynamic asset allocation. Specifically, market liquidity risk premium cycles anticipate economic and market cycles. Investors can therefore act to avoid markets with low liquidity premiums, waiting to extract liquidity risk premiums when the likelihood of extracting a liquidity premium improves. The result, meaningfully enhanced portfolio performance through economic and market cycles, and is robust to transactions costs and alternate specifications.

Keywords: asset allocation, dynamic asset allocation, liquidity

JEL Classification: G1, G12

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Date posted: November 28, 2012 ; Last revised: June 19, 2014

Suggested Citation

Xiong, James X. and Sullivan, Rodney N and Wang, Peng, Liquidity-Driven Dynamic Asset Allocation (August 28, 2012). Journal of Portfolio Management, Forthcoming. Available at SSRN: http://ssrn.com/abstract=2181519

Contact Information

James X. Xiong
Ibbotson Associates ( email )
United States
Rodney N Sullivan (Contact Author)
AQR Capital Management ( email )
Two Greenwich Plza
Greenwich, CT 06830
United States
HOME PAGE: http://www.aqr.com/Home.aspx
Peng Wang
University of Virginia - Investment Management Company ( email )
Post Office Box 400215
Charlottesville, VA 22904-4215
United States
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