Illiquid Assets and Optimal Portfolio Choice

UCLA Anderson School of Management Paper No. 18-04

48 Pages Posted: 4 Mar 2005

See all articles by Claudio Tebaldi

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance; Bocconi University - Department of Finance; Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research

Eduardo S. Schwartz

Simon Fraser University (SFU); University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)

Date Written: February 2005

Abstract

The presence of illiquid assets, such as human wealth, housing and proprietorships substantially complicates the problem of portfolio choice. This paper is concerned with the problem of optimal asset allocation in a continuous time model when one asset cannot be traded. This illiquid asset, which depends on an uninsurable source of risk, provides a liquid dividend. In the case of human capital we can think about this dividend as labor income. The agent is endowed with a given amount of the illiquid asset and with some liquid wealth which can be allocated in a market where there is a risky and a riskless asset. The main point of the paper is that the optimal allocations to the two liquid assets and consumption will critically depend on the endowment and characteristics of the illiquid asset, in addition to the preferences and liquid wealth of the agent. We provide what we believe to be the first analytical solution to this problem when the agent has power utility of consumption and terminal wealth. We also derive the value that the agent assigns to the illiquid asset. The risk adjusted valuation procedure we develop can be used to value both liquid and illiquid assets, as well as contingent claims on those assets.

Keywords: Dynamic portfolio choice

JEL Classification: D9

Suggested Citation

Tebaldi, Claudio and Schwartz, Eduardo S., Illiquid Assets and Optimal Portfolio Choice (February 2005). UCLA Anderson School of Management Paper No. 18-04, Available at SSRN: https://ssrn.com/abstract=676341 or http://dx.doi.org/10.2139/ssrn.676341

Claudio Tebaldi (Contact Author)

Bocconi University - CAREFIN - Centre for Applied Research in Finance ( email )

Via Roentgen 1
Milan, 20136
Italy

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - IGIER - Innocenzo Gasparini Institute for Economic Research ( email )

Via Roentgen 1
Milan, 20136
Italy

Eduardo S. Schwartz

Simon Fraser University (SFU) ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1953 (Phone)
310-206-5455 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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