The Shadow Price of Liquidity in Asset Allocation – A Case Study

Bac Van Luu, Yazid Sharaiha, Nikolay Doskov, Chirag Patel and David Turkington

Volume 12, Number 2, Second Quarter 2014

We apply a framework for estimating the investor-specific value of liquidity which can be used to inform asset allocation decisions. The shadow price of liquidity is a central concept in this framework. In the case study, the investor considers allocation to private equity, real estate, and infrastructure alongside a public equity and bond portfolio. Given the assumptions made on how this investor uses portfolio liquidity, we find that the shadow cost of liquidity is less than 1%. In other words, the additional return required for taking on illiquidity risk is not very demanding for the case in question, but may be higher for other investors.