Market Closure, Portfolio Selection, and Liquidity Premia

摘要

Constantinides (1986) finds that transaction cost has only a second order effect on liquidity premia. In this paper, we show that simply incorporating the well-established time-varying return dynamics across trading and nontrading periods generates a first order effect that is much greater than that found by the existing literature and com- parable to empirical evidence. Surprisingly, the higher liquidity premium is Not from higher trading frequency, but mainly from the substantially suboptimal trading strat- egy chosen to control transaction costs. In addition, we show that adopting strategies prescribed by standard models that assume a continuously open market and constant return dynamics can result in significant utility loss. Furthermore, our model pre- dicts that trading volume is greater at market close and market open than the rest of trading times.