Mitigating portfolio risks: The equilibrium effects of non-tradable assets on optimal policy portfolios

In a study published in the journal China Finance Review International, the authors embark on a journey into the intricate realm of non-tradable assets and their profound influence on optimal policy portfolios. They meticulously dissect the equilibrium effects of these assets on the asset allocation decisions of investors—those privileged with access and those without.

Through an in-depth theoretical analysis, the authors meticulously construct a model that encompasses both tradable and non-tradable asset classes, each endowed with jointly normally distributed cash flows. Two distinct groups of investors take the stage: those who have the privilege of non-tradable assets and those who do not.

All investors share constant absolute risk aversion preferences. The authors astutely derive closed-form solutions for optimal investor demand and equilibrium asset prices, even calibrating their model with US data spanning listed equity, bonds, and private equity. Moreover, they unravel the intricacies of quantities and prices in response to key parameters.

The presence of non-tradable assets significantly reshapes optimal asset allocation strategies. Investors holding non-tradable assets tend to fine-tune their portfolios of tradable assets, gravitating away from those assets correlated with non-tradable assets exhibiting positive betas.

This study holds pivotal significance for not only investors who possess non-tradable assets, such as private equity but also for those yet to access them. It underscores a crucial point—ignoring the impact of non-tradable assets when reverse-engineering risk premia from asset covariances and market capitalizations may inadvertently lead to an underestimation of the equity risk premium.

With this comprehensive analysis, the authors shed a bright light on the equilibrium effects of non-tradability within optimal policy portfolios in a manner that transcends the exploration of market imperfections influencing individual portfolio choices.

To sum it up, this paper offers an exceptional perspective on portfolio choices and equilibrium prices. It unveils the intricate world of non-tradable assets and their far-reaching influence across the financial landscape.

More information:
Otto Randl et al, Equilibrium policy portfolios when some investors are restricted from holding certain assets, China Finance Review International (2022). DOI: 10.1108/CFRI-07-2022-0121

Provided by Shanghai Jiao Tong University Journal Center