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On the Scholes liquidation problem

Author: David B Brown; Bruce I Carlin; Miguel Sousa Lobo; National Bureau of Economic Research.
Publisher: Cambridge, Mass. : National Bureau of Economic Research, ©2009.
Series: Working paper series (National Bureau of Economic Research), no. 15381.
Edition/Format:   eBook : Document : EnglishView all editions and formats
Summary:
How should an investor unwind a portfolio in the face of recurring and uncertain liquidity needs? We propose a model of portfolio liquidation in two periods to investigate this question, initially posed by Myron Scholes following the fall of Long Term Capital Management. We show that when the expectation of future liquidity needs is low, the optimal solution involves selling assets that have low permanent and  Read more...
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Details

Named Person: Myron S Scholes; Myron S Scholes
Material Type: Document, Internet resource
Document Type: Internet Resource, Computer File
All Authors / Contributors: David B Brown; Bruce I Carlin; Miguel Sousa Lobo; National Bureau of Economic Research.
OCLC Number: 440848850
Notes: "September 2009."
Description: 1 online resource (37 pages) : illustrations, digital.
Series Title: Working paper series (National Bureau of Economic Research), no. 15381.
Responsibility: David B. Brown, Bruce Ian Carlin, Miguel Sousa Lobo.

Abstract:

How should an investor unwind a portfolio in the face of recurring and uncertain liquidity needs? We propose a model of portfolio liquidation in two periods to investigate this question, initially posed by Myron Scholes following the fall of Long Term Capital Management. We show that when the expectation of future liquidity needs is low, the optimal solution involves selling assets that have low permanent and temporary price impacts of trading. However, when there is a high probability of a large future liquidity need, the optimal solution involves retaining assets that have a small temporary impact of trading. In the face of potential future adversity, there is a high option-value to the temporary component of liquidity. The permanent component of liquidity does not share this feature, so that investors will prefer to sell assets with a low ratio of permanent to temporary price impact in the early stages of a crisis, and to hold on to assets with a high ratio of permanent to temporary price impact to protect themselves against an aggravation of the crisis.

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