Where Experience Matters: Asset Allocation and Asset Pricing with Opaque and Illiquid Assets

Alternative assets, such as private equity, hedge funds, and real assets, are illiquid and opaque, and thus pose a challenge to traditional models of asset allocation. In this paper, we study asset allocation and asset pricing in a general-equilibrium model with liquid assets and an alternative risky asset, which is opaque and incurs transaction costs, and investors who differ in their experience in assessing the alternative asset. We find that the optimal asset-allocation strategyof the relatively inexperienced investors is to initially tilt their portfolio away from the alternative asset and to hold more of it with experience. counterintuitively, a decrease in the transaction cost for the alternative asset increases the portfolio tilt at the initial date, and hence, the liquidity discount.