The Irrelevance of Lending-Value Constraints in Long-Term Portfolio Optimization: A Twenty-Year Analysis Spanning Two Financial Crises

This study examines the potential benefits of incorporating a lending-value criterion into the design of portfolios with long-term objectives. Because such portfolios often include significant positions in illiquid assets—typically difficult to sell under stressful market conditions—it has been argued that they should be designed with this constraint in mind. The underlying idea is that portfolios with adequate borrowing capacity may be better able to withstand adverse market conditions and thus avoid the losses incurred when managers are forced to sell assets under duress. Using returns data over a twenty-year period, which included two major financial crises, the study finds that the potential benefits of this approach are minimal. In other words, adding a lending-value constraint to the optimization problem is largely irrelevant, since in most cases the constraint is not binding. Put differently, the asset weights selected under the standard optimization framework already yield portfolios with an adequate lending value.