The Shadow Costs of Illiquidity

Journal of Financial and Quantitative Analysis (JFQA), Forthcoming

49 Pages Posted: 25 Aug 2020 Last revised: 25 Jan 2021

See all articles by Kristy A.E. Jansen

Kristy A.E. Jansen

Tilburg University; De Nederlandsche Bank - Research Department

Bas J. M. Werker

Tilburg University - Center for Economic Research (CentER)

Date Written: August 23, 2020

Abstract

We solve a flexible model that captures transactions costs and infrequencies of trading opportunities for illiquid assets to better understand the shadow costs of illiquidity for different origins of asset illiquidity and heterogeneous investor types. We show that illiquidity that results in suboptimal asset allocation carries low shadow costs, whereas these costs are high when illiquidity restricts consumption. As a result, the shadow costs are high for short-term investors, investors who face substantial liquidity shocks, and investors who desire to allocate a large fraction of their wealth to illiquid assets.

Keywords: illiquid assets, infrequent trades, portfolio choice, shadow costs, transaction costs

JEL Classification: G11, G12

Suggested Citation

Jansen, Kristy A.E. and Werker, Bas J.M., The Shadow Costs of Illiquidity (August 23, 2020). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3679461 or http://dx.doi.org/10.2139/ssrn.3679461

Kristy A.E. Jansen (Contact Author)

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

De Nederlandsche Bank - Research Department ( email )

P.O. Box 98
1000 AB Amsterdam
Netherlands

Bas J.M. Werker

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
5000 LE Tilburg
Netherlands

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