This paper examines the optimal allocation of risk across generations whose savings mix is subject to illiquidity in the form of uncertain trading costs. We use a stylized two-period OLG framework, where each generation makes a portfolio allocation decision for retirement, and show that illiquidity reduces the range of transferable shocks between generations and thus lowers the benefits of risk-sharing. Higher illiquidity then may justify higher levels of risk sharing to compensate for the trading friction. We still find that a contingent transfers policy based on a reasonably parametrized savings portfolio with liquid and illiquid assets increases aggregate welfare.
Recommended citation: Dimitrov, Daniel, Intergenerational Risk Sharing with Market Liquidity Risk (March 30, 2022). Tinbergen Institute Discussion Paper 2022-028/V, Available at SSRN: https://ssrn.com/abstract=4084778 or http://dx.doi.org/10.2139/ssrn.4084778