The Risk-Return Trade-off in-Converting Wealth into Cash

Abstract

This article examines the risk-return trade-off an individual or trustee who decides to liquidate a position in an asset. Converting concentrated wealth into cash is not without risk as it may not be instantaneous. Just like the selection of an optimal asset mix along the “efficient frontier,” the liquidation problem requires careful balancing of the exposure to the asset return variance (risk) against sale-induced price concessions (cost). An appealing decision tool is found in a value-at-risk function used by banks to manage overall trading risk. The individual maximizes the expected profit from the sale strategy minus a penalty function for exposure to the price risk. The penalty “weight” is related to a selected loss confidence interval.