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Portfolio Choice with Illiquid Assets

Listed author(s):
  • Andrew Ang
  • Dimitris Papanikolaou
  • Mark Westerfield

We present a model of optimal allocation over liquid and illiquid assets, where illiquidity is the restriction that an asset cannot be traded for intervals of uncertain duration. Illiquidity leads to increased and state-dependent risk aversion, and reduces the allocation to both liquid and illiquid risky assets. Uncertainty about the length of the illiquidity interval, as opposed to a deterministic non-trading interval, is a primary determinant of the cost of illiquidity. We allow market liquidity to vary from `normal' periods, when all assets are fully liquid, to 'illiquidity crises,' when some assets can only be traded infrequently. The possibility of a liquidity crisis leads to limited arbitrage in normal times. Investors are willing to forego 2% of their wealth to hedge against illiquidity crises occurring once every ten years.

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File URL: http://www.nber.org/papers/w19436.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19436.

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Date of creation: Sep 2013
Publication status: published as “Portfolio Choice with Illiquid Assets,” with Dimitris Papanikolaou and Mark M. Westerfield, 2014, Management Science, 60, 11, 2737-2761.
Handle: RePEc:nbr:nberwo:19436
Note: AP
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