The Shadow Price of Liquidity in Asset Allocation - A Case Study
Journal of Investment Management (JOIM), Second Quarter 2014
Posted: 15 Nov 2014
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
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