Portfolio Choice with Illiquid Assets

47 Pages Posted: 22 Apr 2011 Last revised: 19 Sep 2014

Multiple version iconThere are 4 versions of this paper

Date Written: August 1, 2013


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.

Keywords: Asset allocation, liquidity, alternative assets, liquidity crises

JEL Classification: G11, G12

Suggested Citation

Ang, Andrew and Papanikolaou, Dimitris and Westerfield, Mark M., Portfolio Choice with Illiquid Assets (August 1, 2013). Netspar Discussion Paper No. 10/2010-092, Available at SSRN: https://ssrn.com/abstract=1817522 or http://dx.doi.org/10.2139/ssrn.1817522

Andrew Ang (Contact Author)

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

University of Washington ( email )

Box 353200
Seattle, WA 98195
United States

HOME PAGE: http://www.markwesterfield.com

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