Pricing Illiquid Assets

Miklos Koren and Adam Szeidl
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Miklos Koren: Harvard University

No 115, Royal Economic Society Annual Conference 2002 from Royal Economic Society

Abstract: The present paper investigates the portfolio allocation decisions of an investor with infinite horizon when available financial assets differ in their degrees of liquidity. A model with risk neutral agents allows us to endogenously determine the liquidity premium. With risk averse agents, we develop a nontrivial portfolio allocation problem, which enables us to calculate the demand for an illiquid asset for any given yield premium. We calibrate and numerically simulate both models. Reasonable parameter values imply a liquidity premium of 1.7% for the risk neutral case. In the portfolio allocation problem we find that a reasonable amount of illiquidity can cause a substantial drop of demand for the asset. We are also able to calculate the price discount at which an agent would be indifferent between immediate sale and waiting for a buyer with a fundamentally justified price.

Date: 2002-08-29
New Economics Papers: this item is included in nep-fin
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Persistent link: https://EconPapers.repec.org/RePEc:ecj:ac2002:115

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