Strategic Allocation to Less Liquid Assets

Abstract

We propose a model to help investors address liquidity questions in strategic asset allocation decisions. We consider various dimensions of liquidity, such as market and funding liquidity, as well as the dynamic nature of liquidity risk and return. Our framework can be particularly useful to help liability-driven investors such as insurance companies and pension funds to utilize their comparative advantage in investing in less liquid assets. We provide a methodology to measure liquidity risk capacity that any investor can use to unlock the liquidity premium in a transparent and robust way without incurring extra risk.

Keywords: liquidity risk, funding, liquidity premium, asset allocation