PORTFOLIO LIQUIDITY MANAGEMENT WITH EXPECTED SHORTFALL CONSTRAINT

In a standard approach to portfolio valuation, it is assumed that a market is perfectly liquid, so assets in the portfolio have unique prices. In practice, however, this does not seem to be true. The asset values may be impacted by the market liquidity deterioration. Also, the liquidity policy, which the portfolio is restricted by, can have an influence on the portfolio value. In this paper, we describe and analyze the relationship between the portfolio value and the liquidity policy. When quantifying the portfolio value, a coherent portfolio risk measure (CPRM) is employed. In the portfolio valuation model, the Power-Law marginal supply-demand curves (MSDCs) are used to deal with the different levels of liquidity of the constituents. The portfolio value is assessed based on the liquidity constraints, cash requirement, minimum weight and portfolio Expected Shortfall (ES) value. These restrictions affect, to a varying degree, the liquidation process of illiquid and high volatility assets. We found that as a liquidity policy becomes stricter with the portfolio ES constraint, the liquidity costs increase significantly. Also, the liquidity costs increased according to the portfolio ES liquidity policy is particularly pronounced as the size of the portfolio becomes larger and the trade duration becomes shorter.