Liquidity in Asset Selection and Asset Class Allocation

Many asset class allocation, asset valuation/selection and asset return anomaly studies ignore or treat lightly the implications of liquidity constraints. What are those implications and how serious are they? In his December 2010 paper entitled “Comatose Markets: What If Liquidity is Not the Norm?”, Aswath Damodaran examines how introducing illiquidity into decision processes affects investors with different time horizons and investment strategies. He focuses on trading friction (brokerage fees, bid-ask spread and price impact) as an illiquidity measurement. Using results from prior research and recent data on liquidity variations within and across asset classes, he finds that: (more…)