Liquidity Premia, Transaction Costs, and Model Misspecification

43 Pages Posted: 10 Mar 2014 Last revised: 11 Jun 2015

See all articles by Bong-Gyu Jang

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH)

Seungkyu Lee

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering

Seyoung Park

Loughborough University - School of Business and Economics

Date Written: March 11, 2014

Abstract

We find robust portfolio rules for ambiguity-averse fund managers in a financial market with proportional transaction costs. The model proposed in this paper permits a liquidity premium much bigger than those found by most empirical literature. Our liquidity premium is much bigger when using reasonably-calibrated parameters, so transaction costs can have a significant effect on investors' optimal investment behaviors. We also show that a high ambiguity aversion could be an explanation for a puzzling feature of economic crises, where liquidity was greatly reduced in the financial market. Our model shows that a fund manager with a higher ambiguity aversion requires much a bigger liquidity premium at times of down markets than at times of up markets.

Keywords: liquidity, robust portfolio, ambiguitiy, fund manager, transaction cost

JEL Classification: G11, G12

Suggested Citation

Jang, Bong-Gyu and Lee, Seungkyu and Park, Seyoung, Liquidity Premia, Transaction Costs, and Model Misspecification (March 11, 2014). Available at SSRN: https://ssrn.com/abstract=2406563 or http://dx.doi.org/10.2139/ssrn.2406563

Bong-Gyu Jang

Pohang University of Science and Technology (POSTECH) ( email )

77 Cheongam-ro
Pohang
Korea, Republic of (South Korea)

Seungkyu Lee

Pohang University of Science and Technology (POSTECH) - Dept. of Industrial and Management Engineering ( email )

Dep. Industrial and Management Engineering POSTECH
San 31 Hyoja-dong Nam-gu
Pohang, Kyung-buk 790-783
Korea
82-(0)10-2790-4237 (Phone)

Seyoung Park (Contact Author)

Loughborough University - School of Business and Economics ( email )

Epinal Way
Leics LE11 3TU
Leicestershire
United Kingdom

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