Illiquidity Effects in Optimal Consumption-Investment Problems
We study the effect of liquidity freezes on an economic agent optimizing her utility of consumption in a perturbed Black-Scholes-Merton model. The single risky asset follows a geometric Brownian motion but is subject to liquidity shocks, during which no trading is possible and stock dynamics are modified. The liquidity regime is governed by a two-state Markov chain. We derive the asymptotic effect of such freezes on optimal consumption and investment schedules in the two cases of (i) small probability of liquidity shock; (ii) fast-scale liquidity regime switching. Explicit formulas are obtained for logarithmic and hyperbolic utility maximizers on infinite horizon. We also derive the corresponding loss in utility and compare with a recent related finite-horizon model of Diesinger, Kraft and Seifried (2009).
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Alessandra Cretarola & Fausto Gozzi & Huyên Pham & Peter Tankov, 2011.
"Optimal consumption policies in illiquid markets,"
Finance and Stochastics,
Springer, vol. 15(1), pages 85-115, January.
- Merton, Robert C., 1971.
"Optimum consumption and portfolio rules in a continuous-time model,"
Journal of Economic Theory,
Elsevier, vol. 3(4), pages 373-413, December.
- R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers 58, Massachusetts Institute of Technology (MIT), Department of Economics.
- Huy�n Pham & Peter Tankov, 2008. "A Model Of Optimal Consumption Under Liquidity Risk With Random Trading Times," Mathematical Finance, Wiley Blackwell, vol. 18(4), pages 613-627.
- Koichi Matsumoto, 2006. "Optimal portfolio of low liquid assets with a log-utility function," Finance and Stochastics, Springer, vol. 10(1), pages 121-145, 01.
- L.C.G. Rogers, 2001. "The relaxed investor and parameter uncertainty," Finance and Stochastics, Springer, vol. 5(2), pages 131-154.
- Luz Rocío Sotomayor & Abel Cadenillas, 2009. "Explicit Solutions Of Consumption-Investment Problems In Financial Markets With Regime Switching," Mathematical Finance, Wiley Blackwell, vol. 19(2), pages 251-279.
When requesting a correction, please mention this item's handle: RePEc:arx:papers:1004.1489. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
If references are entirely missing, you can add them using this form.