Reconsidering Asset Allocation Involving Illiquid Assets

22 Pages Posted: 25 Mar 2008

See all articles by Dan Cao

Dan Cao

Georgetown University - Department of Economics

Jerome Teiletche


Date Written: 2007


Alternative assets are gaining increasing importance in investor's portfolios. One of their defining characteristic is their poor liquidity which often translates into an inherent smoothing process of the returns. For asset allocation purposes, this feature has to be seriously addressed as it leads to a severe underestimation of the variance of returns and their correlation with other (standard) assets. In this article, in order to deal with practical issues, we extend previous researches which model the smoothing process as a moving average one in several directions: (i) we propose a correction for the case of numerous illiquid assets; (ii) we investigate the implications of the standard practice of fitting autoregressive models in place of moving average models for the correction of the returns variance; (iii) we provide generalization to the case where the returns process is jointly governed by smoothing and true (economically) time-dependent behaviour. All the theoretical results are illustrated empirically with applications to US real estate and venture capital indexes.

Keywords: illiquidity, smoothing, alternative assets

JEL Classification: G00

Suggested Citation

Cao, Dan and Teiletche, Jerome, Reconsidering Asset Allocation Involving Illiquid Assets (2007). Available at SSRN: or

Dan Cao

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States

Jerome Teiletche (Contact Author)

Unigestion ( email )

8c, avenue de Champel CP 387
CP 387
Genève 12, CH 1211

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