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Optimal portfolio liquidation with distress risk

Publication ,  Journal Article
Brown, DB; Carlin, BI; Lobo, MS
Published in: Management Science
November 1, 2010

We analyze the problem of an investor who needs to unwind a portfolio in the face of recurring and uncertain liquidity needs, with a model that accounts for both permanent and temporary price impact of trading. We first show that a risk-neutral investor who myopically deleverages his position to meet an immediate need for cash always prefers to sell more liquid assets. If the investor faces the possibility of a downstream shock, however, the solution differs in several important ways. If the ensuing shock is sufficiently large, the nonmyopic investor unwinds positions more than immediately necessary and, all else being equal, prefers to retain more of the assets with low temporary price impact in order to hedge against possible distress. More generally, optimal liquidation involves selling strictly more of the assets with a lower ratio of permanent to temporary impact, even if these assets are relatively illiquid. The results suggest that properly accounting for the possibility of future shocks should play a role in managing large portfolios. © 2010 INFORMS.

Duke Scholars

Published In

Management Science

DOI

EISSN

1526-5501

ISSN

0025-1909

Publication Date

November 1, 2010

Volume

56

Issue

11

Start / End Page

1997 / 2014

Related Subject Headings

  • Operations Research
  • 46 Information and computing sciences
  • 38 Economics
  • 35 Commerce, management, tourism and services
  • 15 Commerce, Management, Tourism and Services
  • 08 Information and Computing Sciences
 

Citation

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Brown, D. B., Carlin, B. I., & Lobo, M. S. (2010). Optimal portfolio liquidation with distress risk. Management Science, 56(11), 1997–2014. https://doi.org/10.1287/mnsc.1100.1235
Brown, D. B., B. I. Carlin, and M. S. Lobo. “Optimal portfolio liquidation with distress risk.” Management Science 56, no. 11 (November 1, 2010): 1997–2014. https://doi.org/10.1287/mnsc.1100.1235.
Brown DB, Carlin BI, Lobo MS. Optimal portfolio liquidation with distress risk. Management Science. 2010 Nov 1;56(11):1997–2014.
Brown, D. B., et al. “Optimal portfolio liquidation with distress risk.” Management Science, vol. 56, no. 11, Nov. 2010, pp. 1997–2014. Scopus, doi:10.1287/mnsc.1100.1235.
Brown DB, Carlin BI, Lobo MS. Optimal portfolio liquidation with distress risk. Management Science. 2010 Nov 1;56(11):1997–2014.

Published In

Management Science

DOI

EISSN

1526-5501

ISSN

0025-1909

Publication Date

November 1, 2010

Volume

56

Issue

11

Start / End Page

1997 / 2014

Related Subject Headings

  • Operations Research
  • 46 Information and computing sciences
  • 38 Economics
  • 35 Commerce, management, tourism and services
  • 15 Commerce, Management, Tourism and Services
  • 08 Information and Computing Sciences