A Regulated Bank Optimal Portfolio with Correlated Liquid and Illiquid Assets

Following a companion paper where we proposed a model of a financial institution that can invest in both liquid and illiquid assets and whose goal is to maximize the profit of its shareholders, while satisfying some capital and liquidity requirements, we now incorporate correlations between the liquid and illiquid asset. This constitutes an intermediate step in an ongoing study whose purpose is to clarify the mechanisms involved in bank regulations. We find that the strength and direction of the linear correlation relationship does not affect the optimal portfolio weights but influences the outcomes for both the shareholders and debt holders