The Shadow Price of Liquidity in Asset Allocation - A Case Study

Journal of Investment Management (JOIM), Second Quarter 2014

Posted: 15 Nov 2014

See all articles by Bac Van Luu

Bac Van Luu

Independent

Y. M. Sharaiha

Independent

Nikolay Doskov

Norges Bank Investment Management (NBIM)

Chirag Patel

Independent

David Turkington

State Street Associates

Date Written: May 22, 2014

Abstract

We apply a framework for estimating the investor-specific value of liquidity which can be used to inform asset allocation decisions. The shadow price of liquidity is a central concept in this framework. In the case study, the investor considers allocation to private equity, real estate and infrastructure alongside a public equity and bond portfolio. Given the assumptions made on how this investor uses portfolio liquidity, we find that the shadow cost of liquidity is less than 1 percent. In other words, the additional return required for taking on illiquidity risk is not very demanding for the case in question, but may be higher for other investors.

Keywords: Illiquidity risk, alternative investments, portfolio optimization, asset allocation, portfolio construction

JEL Classification: G00

Suggested Citation

Luu, Bac Van and Sharaiha, Y. M. and Doskov, Nikolay and Patel, Chirag and Turkington, David, The Shadow Price of Liquidity in Asset Allocation - A Case Study (May 22, 2014). Journal of Investment Management (JOIM), Second Quarter 2014, Available at SSRN: https://ssrn.com/abstract=2440973

Y. M. Sharaiha

Independent

Nikolay Doskov

Norges Bank Investment Management (NBIM) ( email )

Bankplassen 2
P.O. Box 1179 Sentrum
Oslo, NO-0107
Norway

Chirag Patel

Independent ( email )

David Turkington

State Street Associates ( email )

United States

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