Abstract
We investigate the optimal asset allocation of an investor who can invest in a fixed-term security that is only traded at time 0. Using a generalized martingale approach, we solve the investor׳s optimal portfolio problem, determine the optimal allocation to fixed-term securities, and provide a representation of trading strategies in terms of a liquidity-related derivative. We apply our approach to two benchmark scenarios: fixed-term fixed-rate bank deposits, and unspanned closed-end securities that can only be traded at time 0. We show that both can be key parts of the investor׳s optimal asset mix, and we investigate the dependence of optimal allocations to fixed-term investments, implied liquidity premia and other characteristics on the underlying model parameters.
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