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Portfolio valuation under liquidity constraints with permanent price impact

Author

Listed:
  • Peter Csoka

    (“Momentum” Game Theory Research Group Centre for Economic and Regional Studies, Hungarian Academy of Sciences and Department of Finance, Corvinus Business School, Corvinus University of Budapest)

  • Judit Hever

    (Department of Finance, Corvinus Business School, Corvinus University of Budapest and Pallas Athéné Domus Educationis Scholarship)

Abstract

When institutional investors rearrange their portfolios, they should consider both the temporary and the permanent price impacts. After a temporary price impact the order book fully recovers, whereas a permanent price impact changes the equilibrium price, having effects on the resulting portfolio. In this paper, for a given period, we introduce an optimization problem for valuing illiquid portfolios with permanent price impacts. We show how to find the optimal trade to satisfy certain portfolio constraints. As a policy implication, we note that introducing permanent price impacts in internal or external regulation can substantially change liquidity risk or capital requirements.

Suggested Citation

  • Peter Csoka & Judit Hever, 2017. "Portfolio valuation under liquidity constraints with permanent price impact," CERS-IE WORKING PAPERS 1736, Institute of Economics, Centre for Economic and Regional Studies.
    • Handle: RePEc:has:discpr:1736
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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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