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This paper examines liquidity and how it affects the behavior of mutual fund portfolio managers, who account for a significant portion of trading in many assets. We define an asset to be perfectly liquid if a portfolio manager can trade the quantity she desires when she desires at a price not worse than the uninformed expected value. A portfolio manager is limited by both what she needs to attain and the ease with which she can attain it, making her sensitive to three dimensions of liquidity: price, timing, and quantity. Deviations from perfect liquidity in any of these dimensions impose shadow costs on the portfolio manager. By focusing on the trade-off between sacrificing on price and quantity instead of the canonical price-time trade-off, the model yields several novel empirical implications. Understanding a portfolio manager's liquidity considerations provides important insights into the liquidity of assets and asset classes.


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© Wiley-Blackwell. Final version published as: Simon Hodrick, L., & Moulton, P. C. (2009). Liquidity: Considerations of a portfolio manager. Financial Management, 38(1), 59-74. Reprinted with permission. All rights reserved.