Portfolio Choice with Illiquid Assets

Andrew Ang, Dimitris Papanikolaou, and Mark M. Westerfield
Management Science 2014, 60(11): 2737-2761
Winner of the Roger F. Murray Prize, Second Place for 2011 (Awarded by the Q-group)

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Summary

We present a simple model of illiquidity based on trading restrictions of uncertain duration. Uncertainty over trading opportunities is much more important than the simple inability to trade.

Abstract

We present a model of optimal allocation to liquid and illiquid assets, where illiquidity risk results from the restriction that an asset cannot be traded for intervals of uncertain duration. Illiquidity risk leads to increased and state-dependent risk aversion, and reduces the allocation to both liquid and illiquid risky assets. Uncertainty about the length of the illiquidity interval, as opposed to a deterministic non-trading interval, is a primary determinant of the cost of illiquidity. We allow market liquidity to vary from ‘normal’ periods, when all assets are fully liquid, to ‘illiquidity crises’, when some assets can only be traded infrequently. The possibility of a liquidity crisis leads to limited arbitrage in normal times. Investors are willing to forego 2% of their wealth to hedge against illiquidity crises occurring once every ten years.

Cite as

Ang, Andrew, Dimitris Papanikolaou, and Mark M. Westerfield. 2014. “Portfolio Choice with Illiquid Assets.” Management Science 60(11): 2737–2761. https://doi.org/10.1287/mnsc.2014.1986

BibTeX

@article{AngPapanikolaouWesterfield2014,
  author  = {Ang, Andrew and Papanikolaou, Dimitris and Westerfield, Mark M.},
  title   = {Portfolio Choice with Illiquid Assets},
  journal = {Management Science},
  year    = {2014},
  volume  = {60},
  number  = {11},
  pages   = {2737--2761},
  doi     = {10.1287/mnsc.2014.1986},
  url     = {https://doi.org/10.1287/mnsc.2014.1986}
}

The PDF posted here is the authors’ manuscript (April 2014 draft). The version of record is available from the journal at the DOI above. Updated October 5, 2026.