Portfolio Choice with Illiquid Assets

47 Pages Posted: 14 Sep 2013 Last revised: 11 Aug 2022

Multiple version iconThere are 4 versions of this paper

Date Written: September 2013


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

Suggested Citation

Ang, Andrew and Papanikolaou, Dimitris and Westerfield, Mark M., Portfolio Choice with Illiquid Assets (September 2013). NBER Working Paper No. w19436, Available at SSRN: https://ssrn.com/abstract=2325809

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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