Improving Portfolio Selection by Balancing Liquidity-Risk-Return: Evidence from Stock Markets

The Modern Portfolio Theory was mathematically structured on the basis of risk-return tradeoff: in other words, riskier investment, greater required potential return. Traditional portfolio optimization models, however, implicitly consider that all assets can be traded at any time and quantity, which is unrealistic. aim to propose a two-stage method includes prior classification liquidity based bid-ask spread mathematical model uses as defined participation constraint. Simulations were carried out using twenty years data from American (NYSE) Brazilian (B3) stock exchanges. results showed developed offers broader range alternatives comprise MV with more realistic approach liquidity. proposed form portfolios respect rules once investor’s risk profile has been defined, making it useful recommendation tool for institutional investors. From conservative point view, also reducing uncertain sales by 10.3% average.