The Impact of Liquidity Constraints on Risk-Return Characteristics of Investment Portfolios

Abstract

In the financial market, the investment portfolio is constructed in various ways, with different components, and under some constraint factors. The Markowitz model, invented by Harry Markowitz, as well as the modern portfolio theory, contributes to the effective construction of portfolios. While the model points out the most efficient portfolios, which are greatly balanced between volatility and return, the change in constraints, which strongly affects the results of the solver, can make some of those potential portfolios impossible, or unfeasible. This study focuses on the setting of constraints on each component’s weight in the whole portfolio, as well as the evaluation of the differences of risk and return rate between the two portfolios under different constraints. The Markowitz model is used to calculate the most efficient portfolios and the efficient frontier under each setting of the constraints. The results of the study show that additional constraints on weights, which are based on the total value of the portfolio and average daily trading value of the stock, make the range of potential volatility rate more limited by controlling the weights of some stocks in the portfolio.