Liquidity and conditional portfolio choice: A nonparametric investigation

Eric Ghysels and João Pedro Pereira

Journal of Empirical Finance, 2008, vol. 15, issue 4, pages 679-699

Abstract: This paper studies the relation between liquidity and optimal portfolio allocations. Given that the portfolio problem of a constant relative risk aversion investor does not have a closed-form solution, we use a nonparametric approach to estimate the optimal allocations. Using a sample of NYSE stocks from 1963-2000, we find that the optimal portfolio weight in small stocks is strongly increasing in liquidity at short daily and weekly horizons. This result is consistent for three different measures of liquidity: price impact, dollar volume, and turnover. However, liquidity does not influence the optimal portfolio choice for large stocks, nor for longer monthly investment horizons.

Date: 2008

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Persistent link: http://EconPapers.repec.org/RePEc:eee:empfin:v:15:y:2008:i:4:p:679-699

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Journal of Empirical Finance is edited by R. T. Baillie, G. Bekaert, W. Ferson, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

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