Abstract
Liquidity is a risk factor of primary relevance that can significantly affect the asset allocation decisions of investors. In this paper, we introduce the concept of portfolio staleness and propose a simple framework to manage portfolio liquidity, intended as the cost needed to liquidate the portfolio. Within this framework, the traditional minimum variance problem is solved under the additional constraint that portfolio staleness must be smaller than a given threshold. We show that a dynamic asset allocation strategy based on the staleness constrained portfolio can significantly enhance portfolio liquidity over the standard minimum variance solution. Meanwhile, the increase in portfolio risk is limited, generating large liquidity gains per unit of risk.
Highlights
The Markowitz (1952) mean–variance framework is at the core of modern asset allocation
Idle time provides information on the extent of liquidity of an asset, and it is related to both transaction costs and absence of volume (Bandi et al 2020). We extend this notion to a portfolio of assets by defining the concept of portfolio staleness: on a given day, portfolio staleness is computed as the weighted average of assets’ idle times, using the corresponding portfolio weights
Building upon the interpretation of idle time as an illiquidity proxy, we introduced the concept of portfolio staleness and showed that it can be effectively used to manage liquidity in a standard minimum-variance framework
Summary
The Markowitz (1952) mean–variance framework is at the core of modern asset allocation. This measure has several attractive features: (a) is easy to compute, as idle time solely requires data on transaction prices to be implemented; (b) has a clear economic interpretation, as idle time can be regarded as an illiquidity proxy within a model of price formation with transaction costs and asymmetric information; (c) being idle time a probability, it naturally ranges between zero and one, allowing to compare and rank portfolios Building upon these considerations, our first contribution is to propose a tractable framework where the liquidity dimension is integrated into the portfolio selection problem.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
