Portfolio Choice with Market Closure and Implications for Liquidity Premia
March 15, 2016
Abstract
Most existing portfolio choice models ignore periodic market closure
and the fact that market volatility is significantly higher during
trading periods. We show that market closure and the volatility
difference across trading and nontrading periods significantly change
optimal trading strategies and produce a U-shape trading volume pattern
that matches empirical evidence. Furthermore, our model implies that
transaction costs can have a first order effect on liquidity premia that
is largely comparable to empirical findings. Extensive empirical
analysis supports the model's unique prediction that stocks with greater
return variance variations across trading and nontrading periods
require higher liquidity premia.