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Portfolio Choice with Market Closure and Implications for Liquidity Premia

Author

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  • Min Dai

    (Department of Mathematics and Risk Management Institute, National University of Singapore, Singapore 119076)

  • Peifan Li

    (Department of Mathematics, National University of Singapore, Singapore 119076)

  • Hong Liu

    (Olin Business School, Washington University in St. Louis, St. Louis, Missouri 63130; and China Academy of Financial Research, Shanghai 200030, China)

  • Yajun Wang

    (Robert H. Smith School of Business, University of Maryland, College Park, Maryland 20742)

Abstract

Most existing portfolio choice models ignore the prevalent periodic market closure and the fact that market volatility is significantly higher during trading periods. We find that market closure and the volatility difference across trading and nontrading periods significantly change optimal trading strategies. In addition, we demonstrate numerically that transaction costs can have a first-order effect on liquidity premia that is largely comparable to empirical findings. Moreover, this effect on liquidity premia increases in the volatility difference, which is supported by our empirical analysis. This paper was accepted by Jerome Detemple, finance .

Suggested Citation

  • Min Dai & Peifan Li & Hong Liu & Yajun Wang, 2016. "Portfolio Choice with Market Closure and Implications for Liquidity Premia," Management Science, INFORMS, vol. 62(2), pages 368-386, February.
    • Handle: RePEc:inm:ormnsc:v:62:y:2016:i:2:p:368-386
    DOI: 10.1287/mnsc.2014.2116
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Masaaki Kijima & Christopher Ting, 2019. "Market Price Of Trading Liquidity Risk And Market Depth," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(08), pages 1-36, December.
    2. Cheng, Chunli & Hilpert, Christian & Miri Lavasani, Aidin & Schaefer, Mick, 2023. "Surrender contagion in life insurance," European Journal of Operational Research, Elsevier, vol. 305(3), pages 1465-1479.
    3. Yang Shen & Bin Zou, 2021. "Mean-Variance Portfolio Selection in Contagious Markets," Papers 2110.09417, arXiv.org.
    4. Bruno Bouchard & Masaaki Fukasawa & Martin Herdegen & Johannes Muhle-Karbe, 2018. "Equilibrium Returns with Transaction Costs," Post-Print hal-01569408, HAL.
    5. Qu, Yan & Dassios, Angelos & Zhao, Hongbiao, 2023. "Shot-noise cojumps: exact simulation and option pricing," LSE Research Online Documents on Economics 111537, London School of Economics and Political Science, LSE Library.
    6. Masaaki Kijima & Christopher Ting, 2019. "Market Price of Trading Liquidity Risk and Market Depth," Papers 1912.04565, arXiv.org.
    7. Jin Hyuk Choi & Tae Ung Gang, 2021. "Optimal investment in illiquid market with search frictions and transaction costs," Papers 2101.09936, arXiv.org, revised Aug 2021.
    8. Grabowski, Wojciech & Welfe, Aleksander, 2020. "The Tobit cointegrated vector autoregressive model: An application to the currency market," Economic Modelling, Elsevier, vol. 89(C), pages 88-100.
    9. Bruno Bouchard & Masaaki Fukasawa & Martin Herdegen & Johannes Muhle-Karbe, 2017. "Equilibrium Returns with Transaction Costs," Papers 1707.08464, arXiv.org, revised Apr 2018.
    10. Johannes Muhle-Karbe & Xiaofei Shi & Chen Yang, 2020. "An Equilibrium Model for the Cross-Section of Liquidity Premia," Papers 2011.13625, arXiv.org.
    11. Kraft, Holger & Weiss, Farina, 2023. "Pandemic portfolio choice," European Journal of Operational Research, Elsevier, vol. 305(1), pages 451-462.
    12. Bruno Bouchard & Masaaki Fukasawa & Martin Herdegen & Johannes Muhle-Karbe, 2018. "Equilibrium returns with transaction costs," Finance and Stochastics, Springer, vol. 22(3), pages 569-601, July.
    13. Aleksy Leeuwenkamp & Wentao Hu, 2023. "New general dependence measures: construction, estimation and application to high-frequency stock returns," Papers 2309.00025, arXiv.org.
    14. Johannes Muhle-Karbe & Max Reppen & H. Mete Soner, 2016. "A Primer on Portfolio Choice with Small Transaction Costs," Papers 1612.01302, arXiv.org, revised May 2017.
    15. Chen, Zheng & Li, Zhongfei & Zeng, Yan, 2023. "Portfolio choice with illiquid asset for a loss-averse pension fund investor," Insurance: Mathematics and Economics, Elsevier, vol. 108(C), pages 60-83.

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