Asset Allocation with Liquidity Constraints and Markov States
Summary
The document asks for methods to manage asset allocation across discrete transition states, with attention to liquidity, trading costs, and delayed cause-and-effect relationships. It contrasts moving from cash directly into an asset with transitions between funds that may require selling to cash first. It also describes cases where a more attractive destination may not justify the cost of switching.
The responses point toward liquidity-risk modeling that accounts for how easily assets can be traded and how this should influence portfolio weights. They also mention Markov methods as a possible way to represent trading states or transitions. However, the document supplies recommendations only at a high level: it gives no formal model, allocation algorithm, empirical evidence, or cost estimates. The references it names would need to be consulted for methods and practical results.
Key ideas
- Asset transitions can involve different numbers of trading steps depending on liquidity and fund structure.
- Switching to a better asset may be unattractive when transaction costs are high.
- Liquidity risk can inform portfolio allocation by accounting for how readily assets can be traded.
- Markov methods are suggested as a way to reason about trading states, but no implementation is provided.
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# Reference material about Quantified Asset Allocation? # Reference material about Quantified Asset Allocation? I am looking for papers that would describe asset allocation with geometry, group theory, markov chains or things like that. Keeping asset allocation in a range is easy but to keep it more precisely is harder. I find it often hard to judge things such as evaluation of trading costs and cause-effect -relationship (particularly when the relationships are long). Here are some phases or states which I would like to control better: - Cash is liquid which can change to any other asset with 2 phase: holding cash and buy another asset. - The change of a fund requires that you sell it first to cash and then to your indented fund -- 3 phase. - Changing fund to the better, 3phase but too expensive better to keep the old. - much more phases! Reference material appreciated. ## Answer by SRKX (score 4) https://quant.stackexchange.com/a/1451 I think you might be interested by an article I mentioned in this post: Carlo Acerbi from MSCI presents in this presentation an innovative approach to liquidity risk. The idea is basically to model how liquid an asset is and how your portfolio allocation should take this risk into account. This way of seeing risk is in my opinion pretty interesting an quite brilliant. Hopefully, it'll be the kind of theory you're looking for. ## Answer by columbus (score 4) https://quant.stackexchange.com/a/1493 Here example of practical application of Markov ideas to trading.
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