Liquidity-Driven Dynamic Asset Allocation

Posted: 28 Nov 2012 Last revised: 10 Mar 2016

James X. Xiong

Ibbotson Associates

Rodney N Sullivan

AQR Capital Management

Peng Wang

TIAA Institute - Covariance Capital Management

Date Written: August 28, 2012

Abstract

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

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: https://ssrn.com/abstract=2181519

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

TIAA Institute - Covariance Capital Management ( email )

1221 McKinney St. Suite 1800
Houston, TX 77010
United States

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