Untangling Illiquidity: Optimal Asset Allocation with Private Asset Classes

Daniel Dimitrov

Working Papers from DNB

Abstract: This paper examines the asset allocation problem faced by long-term investors seeking exposure to illiquid private assets. Liquidity uncertainty hampers continuous rebalancing and withdrawals, while illiquidity risk premia can lead to unintended overallocation during extended periods of asset lock-ups, increasing the variability of portfolio consumption and shrinking investor welfare. Using a dynamic allocation model calibrated on analyst-based capital market expectations, I find that while adding private assets to the investment universe may offer benefits, ignoring illiquidity in the portfolio construction process leads to substantial welfare losses.

Keywords: asset allocation; (il)liquidity; private assets; model misspecification (search for similar items in EconPapers)
JEL-codes: D81 E21 G11 G12 (search for similar items in EconPapers)
Date: 2025-01
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