Portfolio choice and pricing in illiquid markets

This paper studies portfolio choice and pricing in markets in which immediate trading may be impossible. It departs from the literature by removing restrictions on asset holdings, and finds that optimal positions depend significantly and naturally on liquidity: When expected future liquidity is high...

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Bibliographic Details
Published in:Journal of economic theory 2009-03, Vol.144 (2), p.532-564
Main Author: Garleanu, N
Format: Article
Language:English
Subjects:
Agency
Discount
Economic theory
Frequency
Liquidity
Liquidity Discount Portfolio choice Trading delays Search Transaction costs
Market structure
Portfolio choice
Portfolio management
Portfolio selection
Pricing
Search
Securities markets
Securities prices
Studies
Trade
Trading delays
Transaction costs
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Summary:This paper studies portfolio choice and pricing in markets in which immediate trading may be impossible. It departs from the literature by removing restrictions on asset holdings, and finds that optimal positions depend significantly and naturally on liquidity: When expected future liquidity is high, agents take more extreme positions, given that they do not have to hold those positions for long when they become undesirable. Consequently, larger trades should be observed in markets with more frequent trading. Liquidity need not affect the price significantly, however, because liquidity has offsetting impacts on different agents' demands. This result highlights the importance of unrestricted portfolio choice. The paper draws parallels with the transaction-cost literature and clarifies the relationship between the price level and the realized trading frequency in this literature.
ISSN:0022-0531
1095-7235
DOI:10.1016/j.jet.2008.07.006