Working Paper: CEPR ID: DP3795
Authors: Miklós Koren; Adam Szeidl
Abstract: The present Paper investigates the effects of incorporating illiquidity in a standard dynamic portfolio choice problem. Lack of liquidity means that an asset cannot be immediately traded at any point in time. We find the portfolio share of financial wealth invested in illiquid assets given the liquidity premium. Benchmark calibrations imply a portfolio share of 2-6% in cash. These numbers are in line with survey data and also with portfolio recommendations by practitioners. We also find that long horizon investors invest more in illiquid assets. Overall, our results suggest that differences between asset classes unrelated to standard price risk may influence portfolio shares.
Keywords: asset pricing; calibration; liquidity; portfolio choice
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| liquidity shocks (E44) | marginal utility (D11) |
| liquidity shocks (E44) | portfolio allocation trade-off (G11) |
| liquidity (E41) | portfolio decisions (G11) |
| liquidity premium (E41) | portfolio share of liquid assets (G11) |
| higher liquidity premiums (G19) | increased cash holdings (G32) |
| liquidity shocks (E44) | buffer stock of cash (E41) |