After taking into account biases induced by infrequent trading and selection, it is unlikely that illiquid asset classes have higher risk-adjusted returns than traditional liquid stock and bond markets. However, there are significant illiquidity premiums within asset classes. Portfolio choice models incorporating illiquidity risk recommend that investors should retain only modest holdings of illiquid assets and demand high risk premiums for investing in them.
Keywords: liquidity premium, survivorship bias, infrequent trading, unsmoothing, de-smoothing, selection bias, illiquidity risk, liquidity crisis, market making, rebalancing, transaction costs, portfolio choice
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