The Liquidity Premium in a Dynamic Model of Portfolio Selection with Price Impact (comments welcomed)
نویسندگان
چکیده
This paper presents a dynamic portfolio choice model to analyze the liquidity premium necessary to compensate an investor for the adverse price impact of trading. By calibrating the model to empirically reasonable parameter values, we generate a plausible liquidity premium. Specifically, the premium is an increasing, concave function of price impact. It increases with the investor’s initial wealth and decreases with the investor’s risk aversion and investment horizon. The optimal equity proportion depends on the investment horizon and initial wealth — even for an investor with constant relative risk aversion. We also find that it is the liquidity level, rather than the liquidity variability, that has the largest effect on the liquidity premium. This fact may help explain the momentum anomaly. ∗CB 3490, Chapel Hill, NC 27599-3490, phone: (919) 962-3154, e-mail: Joao [email protected]. Financial support from the Portuguese Science and Technology Foundation is gratefully acknowledged. †CB 3490, Chapel Hill, NC 27599-3490, phone: (919) 843-8340, e-mail:[email protected]
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