Portfolio Liquidity and Diversification: Theory and Evidence

49 Pages Posted: 11 Aug 2017

See all articles by Lubos Pastor

Lubos Pastor

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Robert F. Stambaugh

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Lucian A. Taylor

University of Pennsylvania - The Wharton School

Multiple version iconThere are 4 versions of this paper

Date Written: August 2017

Abstract

A portfolio's liquidity depends not only on the liquidity of its holdings but also on its diversification. We propose simple, theoretically motivated measures of portfolio liquidity and diversification. We also develop an equilibrium model relating portfolio liquidity to fund size, expense ratio, and turnover. As the model predicts, mutual funds with less liquid portfolios have smaller size, higher expense ratios, and lower turnover. The model also yields additional predictions that we verify empirically: larger funds are cheaper, funds that trade less are larger and cheaper, and funds that are too big perform worse. We also find that mutual fund portfolios have become more liquid because both components of diversification, coverage and balance, have trended upward.

Keywords: Diversification, Mutual funds, portfolio liquidity

JEL Classification: G11, G23

Suggested Citation

Pastor, Lubos and Stambaugh, Robert F. and Taylor, Lucian A., Portfolio Liquidity and Diversification: Theory and Evidence (August 2017). CEPR Discussion Paper No. DP12195. Available at SSRN: https://ssrn.com/abstract=3016781

Lubos Pastor (Contact Author)

University of Chicago - Booth School of Business ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Robert F. Stambaugh

University of Pennsylvania - The Wharton School ( email )

The Wharton School, Finance Department
University of Pennsylvania
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National Bureau of Economic Research (NBER)

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Lucian A. Taylor

University of Pennsylvania - The Wharton School ( email )

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Philadelphia, PA 19104-6365
United States

HOME PAGE: http://finance.wharton.upenn.edu/~luket/

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