Liquidity Regimes and Optimal Dynamic Asset Allocation

68 Pages Posted: 22 Jan 2018

See all articles by Pierre Collin-Dufresne

Pierre Collin-Dufresne

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute; National Bureau of Economic Research (NBER)

Kent D. Daniel

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Mehmet Saglam

University of Cincinnati - Department of Finance - Real Estate

Multiple version iconThere are 3 versions of this paper

Date Written: January 2018

Abstract

We solve a portfolio choice problem when expected returns, volatilities and trading-costs follow a regime-switching model. The optimal policy trades towards an aim portfolio given by a weighted-average of the conditional mean-variance portfolios in all future states. The trading speed is higher in more persistent, riskier and higher-liquidity states. It can be optimal to overweight low Sharpe-ratio assets such as Treasury bonds because they remain liquid even in crisis states. We illustrate our methodology by constructing an optimal US equity market timing portfolio based on an estimated regime-switching model and on trading costs estimated using a large-order institutional trading dataset.

Suggested Citation

Collin-Dufresne, Pierre and Daniel, Kent D. and Saglam, Mehmet, Liquidity Regimes and Optimal Dynamic Asset Allocation (January 2018). NBER Working Paper No. w24222. Available at SSRN: https://ssrn.com/abstract=3106663

Pierre Collin-Dufresne (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

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Swiss Finance Institute

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National Bureau of Economic Research (NBER)

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Kent D. Daniel

Columbia Business School - Finance and Economics ( email )

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212-854-4679 (Fax)

HOME PAGE: http://kentdaniel.net/

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

Mehmet Saglam

University of Cincinnati - Department of Finance - Real Estate ( email )

Carl H. Lindner College of Business
Cincinnati, OH 45221
United States
(513) 556-9108 (Phone)

HOME PAGE: http://homepages.uc.edu/~saglammt/

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