IT'S 11 PM—DO YOU KNOW WHERE YOUR LIQUIDITY IS?: THE MEAN–VARIANCE–LIQUIDITY FRONTIER

Andrew Lo (), Constantin Petrov and Martin Wierzbicki
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Constantin Petrov: Research Analyst, Fidelity Management and Research Co., 82 Devonshire Street, Boston, MA 02109, USA
Martin Wierzbicki: 838 Green Street, San Francisco, CA 94133, USA

Chapter 3 in The World of Risk Management, 2005, pp 47-92 from World Scientific Publishing Co. Pte. Ltd.

Abstract: AbstractWe introduce liquidity into the standard mean–variance portfolio optimization framework by defining several measures of liquidity and then constructing three-dimensional mean–variance–liquidity frontiers in three ways: liquidity filtering, liquidity constraints, and a mean–variance–liquidity objective function. We show that portfolios close to each other on the traditional mean–variance efficient frontier can differ substantially in their liquidity characteristics. In a simple empirical example, the liquidity exposure of mean–variance efficient portfolios changes dramatically from month to month, and even simple forms of liquidity optimization can yield significant benefits in reducing a portfolio's liquidity-risk exposure without sacrificing a great deal of expected return per unit risk.

Keywords: Risk; Risk Analysis; Risk Management; Investment Management; Portfolio Management; Security Analysis; Asset Analysis (search for similar items in EconPapers)
Date: 2005
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