Asset Allocation and Liquidity Breakdowns : What If Your Broker Does Not Answer the Phone?

This paper analyzes the portfolio decision of an investor facing the threat of illiquidity. In a continuous-time setting, the efficiency loss due to illiquidity is addressed and quantified. We show that the efficiency loss for a logarithmic investor with 30 years until the investment horizon is a significant 22.7% of current wealth if the illiquidity part of the model is calibrated to the Japanese data of the aftermath of WW II. Furthermore, it is demonstrated that the threat of illiquidity can change the demand for risky securities tremendously and that a logarithmic investor will not behave myopically anymore