Optimal Asset Allocation Subject to Liquidity and Withdrawal Risks
39 Pages Posted: 8 Jan 2021
Date Written: November 13, 2020
This study investigates the optimal asset allocation of a financial institution subject to liquidity risks and whose customers are free to withdraw their capital-guaranteed financial contracts at any time. Accounting for constraints on the solvency of the institution, we present a general optimization problem and provide a dynamic programming principle for the optimal dynamic investment strategies. Furthermore, we consider an explicit context, including the interest rate and credit intensity fluctuations, and show, by numerical results, that the optimal strategy improves the solvency and the asset returns of the institution compared to the baseline asset allocation.
Keywords: Asset allocation, ALM, liquidity risk, withdrawal risk
JEL Classification: G11, G21, G22
Suggested Citation: Suggested Citation