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The Shadow Costs of Illiquidity

Published online by Cambridge University Press:  29 April 2022

Kristy A. E. Jansen Open the ORCID record for Kristy A. E. Jansen [Opens in a new window]  and
Bas J. M. Werker
Kristy A. E. Jansen*
Affiliation:
University of Southern California Marshall School of Business and De Nederlandsche Bank Economics and Research Department
Bas J. M. Werker
Affiliation:
Tilburg University Department of Econometrics and Operations Researchb.j.m.werker@tilburguniversity.edu
*
kjansen@marshall.usc.edu (corresponding author)
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Abstract

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We solve a flexible model that captures transactions costs and infrequencies of trading opportunities for illiquid assets to better understand the shadow costs of illiquidity for different origins of asset illiquidity and heterogeneous investor types. We show that illiquidity that results in suboptimal asset allocation carries low shadow costs, whereas these costs are high when illiquidity restricts consumption. As a result, the shadow costs are high for short-term investors, investors who face substantial liquidity shocks, and investors who desire to allocate a large fraction of their wealth to illiquid assets.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 57 , Issue 7 , November 2022 , pp. 2693 - 2723
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank an anonymous referee, Hendrik Bessembinder (the editor), Jules van Binsbergen, Marie Brière, Dirk Broeders, Joost Driessen, Esther Eiling, Frank de Jong, Ralph Koijen, Olivia Mitchell, Theo Nijman, Antoon Pelsser, Patrick Tuijp, seminar participants at Tilburg University, the Wharton School, Maastricht University, Ortec Finance Canada, Ortec Finance Rotterdam, Achmea Investment Management, Robeco, and conference participants of the 2018 Market Microstructure & High Frequency Data Stevanovich Center University of Chicago, 2019 SoFiE, 2018 Netspar Pension Day, and the 2019 International Pension Workshop for very useful comments. Jansen gratefully acknowledges financial support from Instituut Gak. Views expressed are those of the author and do not necessarily reflect official positions of De Nederlandsche Bank.

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