Portfolio Choice with Market Closure and Implications for Liquidity Premia

Most existing portfolio choice models ignore the prevalent periodic market closure and the fact that market volatility is significantly higher during trading periods. We find that market closure and the volatility difference across trading and nontrading periods significantly change optimal trading strategies. In addition, we demonstrate numerically that transaction costs can have a first-order effect on liquidity premia that is largely comparable to empirical findings. Moreover, this effect on liquidity premia increases in the volatility difference, which is supported by our empirical analysis.

This paper was accepted by Jerome Detemple, finance.