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Portfolio Choice with Illiquid Assets

Andrew Ang

BlackRock, Inc

Dimitris Papanikolaou

Northwestern University - Kellogg School of Management - Department of Finance; National Bureau of Economic Research (NBER)

Mark M. Westerfield

University of Washington

April 2014

We present a model of optimal allocation to liquid and illiquid assets, where illiquidity risk results from the restriction that an asset cannot be traded for intervals of uncertain duration. Illiquidity risk 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.

Number of Pages in PDF File: 46

Keywords: Asset Allocation, Liquidity, Alternative Assets, Liquidity Crises

JEL Classification: G11, G12

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Date posted: October 26, 2010 ; Last revised: October 1, 2014

Suggested Citation

Ang, Andrew and Papanikolaou, Dimitris and Westerfield, Mark M., Portfolio Choice with Illiquid Assets (April 2014). Available at SSRN: https://ssrn.com/abstract=1697784 or http://dx.doi.org/10.2139/ssrn.1697784

Contact Information

Andrew Ang
BlackRock, Inc ( email )
55 East 52nd Street
New York City, NY 10055
United States
Dimitris Papanikolaou
Northwestern University - Kellogg School of Management - Department of Finance ( email )
Evanston, IL 60208
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Mark M. Westerfield (Contact Author)
University of Washington ( email )
Box 353200
Seattle, WA 98195
United States
HOME PAGE: http://www.markwesterfield.com
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