The Shadow Costs of Illiquidity
Journal of Financial and Quantitative Analysis (JFQA), Forthcoming
49 Pages Posted: 25 Aug 2020 Last revised: 25 Jan 2021
Date Written: August 23, 2020
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: Suggested Citation