Consumption-portfolio choice with preferences for liquid assets (2503.02697v1)

Abstract: This paper investigates an infinite horizon, discounted, consumption-portfolio problem in a market with one bond, one liquid risky asset, and one illiquid risky asset with proportional transaction costs. We consider an agent with liquidity preference, modeled by a Cobb-Douglas utility function that includes the liquid wealth. We analyze the properties of the value function and divide the solvency region into three regions: the buying region, the no-trading region, and the selling region, and prove that all three regions are non-empty. We mathematically characterize and numerically solve the optimal policy and prove its optimality. Our numerical analysis sheds light on the impact of various parameters on the optimal policy, and some intuition and economic insights behind it are also analyzed. We find that liquidity preference encourages agents to retain more liquid wealth and inhibits consumption, and may even result in a negative allocation to the illiquid asset. The liquid risky asset not only affects the location of the three regions but also has an impact on consumption. However, whether this impact on consumption is promoted or inhibited depends on the degree of risk aversion of agents.