Rather, for the issues I’m discussing here to matter, the investment must be very illiquid as much of the point is being able to ignore its volatility, not just having to sell it over three days instead of one hour, or that your trading costs are somewhat higher.
I don’t think I’m contradicting the idea that if one stock is somewhat less liquid than another perhaps you need an expected return premium to own it. But, what if this is backwards? What if investors will actually pay a higher price and accept a lower expected return for very illiquid assets? 3 3 Close As you’ll see, the assets need to be very illiquid for what we’ll discuss to kick in. Illiquidity is a bad thing, and, all else equal, you need to be paid extra for taking it on. (To make things worse, some use the term liquidity premium for the same concept when I think they really mean illiquidity premium I won’t.) I mainly choose the expected return framework but often present it both ways choosing clarity over elegance. You can call this an illiquidity premium if you’re framing it in terms of expected returns or an illiquidity discount if you’re framing it in terms of purchase prices (which, of course, move opposite from expected returns going forward). 2 2 Close The terminology can be confusing. Conventional wisdom is you get an expected return premium for bearing illiquidity. It’s one we’ve been bandying about for at least a decade, but it seems increasingly relevant these days.
Implied in my parody 1 1 Close You knew it was a parody right?Īnd more explicit in my colleagues’ excellent work on private equity (PE) is a rather bold notion.
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