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Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off
Author(s) -
WAGNER WOLF
Publication year - 2011
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2011.01666.x
Subject(s) - diversification (marketing strategy) , portfolio , incentive , systemic risk , business , asset (computer security) , systematic risk , economics , financial economics , monetary economics , financial crisis , microeconomics , computer security , marketing , computer science , macroeconomics
This paper proposes a portfolio choice model in which investors are subject to liquidation risk and (endogenously) face higher costs in the event of joint liquidation (as was observed during the crisis of 2008 to 2009). The risk of joint liquidation creates an incentive for investors to choose heterogeneous portfolios and to rationally forgo diversification benefits. Joint liquidation risk is also reflected in asset prices, resulting in (1) assets with high idiosyncratic risk having low expected returns, and (2) assets that display high correlation with the portfolios of (liquidation‐prone) investors having high expected returns.