It's 11pm - Do You Know Where Your Liquidity is? The Mean-Variance Liquidity Frontier

Journal Of Investment Management, Vol. 1, No. 1, First Quarter 2003

Posted: 27 Aug 2006

See all articles by Andrew W. Lo

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Constantin Petrov

affiliation not provided to SSRN

Martin Wierzbicki

affiliation not provided to SSRN

Abstract

We introduce liquidity into a mean-variance portfolio optimization framework by defining several measures of liquidity and then constructing three-dimensional mean-variance-liquidity frontiers in three ways - liquidity filtering, liquidity constraints, and a mean-variance-liquidity objective function. We show that portfolios close to each other on the traditional mean-variance efficient frontier can differ substantially in their liquidity characteristics. In a simple empirical example, the liquidity exposure of mean-variance efficient portfolios change dramatically from month to month, and even simple forms of liquidity optimization can yield significant benefits in reducing a portfolio's liquidity-risk exposure without sacrificing a great deal of expected return per unit risk.

Keywords: Liquidity, Portfolio Optimization, Transaction, Costs, Visualization

JEL Classification: G00

Suggested Citation

Lo, Andrew W. and Petrov, Constantin and Wierzbicki, Martin, It's 11pm - Do You Know Where Your Liquidity is? The Mean-Variance Liquidity Frontier. Journal Of Investment Management, Vol. 1, No. 1, First Quarter 2003. Available at SSRN: https://ssrn.com/abstract=495103

Andrew W. Lo (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
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Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

Constantin Petrov

affiliation not provided to SSRN ( email )

No Address Available

Martin Wierzbicki

affiliation not provided to SSRN

No Address Available

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