Portfolio choice with market closure and implications for liquidity premia

Most existing portfolio choice models ignore periodic market closure and the fact that market volatility is significantly higher during trading periods. We show that market closure and the volatility difference across trading and nontrading periods significantly change optimal trading strategies and produce a U-shape trading volume pattern that matches empirical evidence. Furthermore, our model implies that transaction costs can have a first order effect on liquidity premia that is largely comparable to empirical findings. Extensive empirical analysis supports the model's unique prediction that stocks with greater return variance variations across trading and nontrading periods require higher liquidity premia.