Portfolio choice with high frequency data: CRRA preferences and the liquidity effect

This paper suggests a new approach for portfolio choice. In this framework, the investor, with CRRA preferences, has two objectives: the maximization of the expected utility and the minimization of the portfolio expected illiquidity. The CRRA utility is measured using the portfolio realized volatili...

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Bibliographic Details
Published in:Portuguese economic journal 2017-08, Vol.16 (2), p.65-86
Main Authors: Brito, R. P., Sebastião, H., Godinho, P.
Format: Article
Language:English
Subjects:
Econometrics
Economic models
Economic Policy
Economic Theory/Quantitative Economics/Mathematical Methods
Economics
Economics and Finance
Expected utility
Investments
Kurtosis
Liquidity
Microeconomics
Minimization
Original Article
Portfolio management
Portfolios
Risk
Robustness
Securities markets
Skewness
Stock market indexes
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Summary:This paper suggests a new approach for portfolio choice. In this framework, the investor, with CRRA preferences, has two objectives: the maximization of the expected utility and the minimization of the portfolio expected illiquidity. The CRRA utility is measured using the portfolio realized volatility, realized skewness and realized kurtosis, while the portfolio illiquidity is measured using the well-known Amihud illiquidity ratio. Therefore, the investor is able to make her choices directly in the expected utility/liquidity (EU/L) bi-dimensional space. We conduct an empirical analysis in a set of fourteen stocks of the CAC 40 stock market index, using high frequency data for the time span from January 1999 to December 2005 (seven years). The robustness of the proposed model is checked according to the out-of-sample performance of different EU/L portfolios relative to the minimum variance and equally weighted portfolios. For different risk aversion levels, the EU/L portfolios are quite competitive and in several cases consistently outperform those benchmarks, in terms of utility, liquidity and certainty equivalent.
ISSN:1617-982X
1617-9838
DOI:10.1007/s10258-017-0131-3