Portfolio Rebalancing with Realization Utility

51 Pages Posted: 7 Mar 2022 Last revised: 26 Jun 2022

See all articles by Min Dai

Min Dai

The Hong Kong Polytechnic University

Cong Qin

Soochow University

Neng Wang

Columbia University - Columbia Business School, Finance; National Bureau of Economic Research (NBER); Asian Bureau of Finance and Economic Research (ABFER)

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Date Written: March 2022

Abstract

We develop a model where a realization-utility investor (Barberis and Xiong, 2009, 2012; Ingersoll and Jin, 2013) optimally targets her liquid-illiquid wealth ratio at a constant w∗. By saving in the risk-free asset (w∗ > 0), she makes smaller bets in the illiquid asset and realizes gains/losses more frequently. By leveraging (w∗ < 0), she makes bets larger than her equity and realizes gains/losses less frequently. For a discontinuous/jump-diffusion price process, the solution features four regions: loss-realization, gain-realization, and two disconnected (deep-loss and normal) holding regions. We generate a quantitatively significant non-monotonic propensity to realize losses consistent with evidence.

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Suggested Citation

Dai, Min and Qin, Cong and Wang, Neng, Portfolio Rebalancing with Realization Utility (March 2022). NBER Working Paper No. w29821, Available at SSRN: https://ssrn.com/abstract=4051255

Min Dai (Contact Author)

The Hong Kong Polytechnic University ( email )

Cong Qin

Soochow University ( email )

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Neng Wang

Columbia University - Columbia Business School, Finance ( email )

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