Working Paper: NBER ID: w20589
Authors: Francis A. Longstaff
Abstract: We model illiquidity as a restriction on the stopping rules investors can follow in selling assets, and apply this framework to the valuation of thinly-traded investments. We find that discounts for illiquidity can be surprisingly large, approaching 30 to 50 percent in some cases. Immediacy plays a unique role and is valued much more than ongoing liquidity. We show that investors in illiquid enterprises have strong incentives to increase dividends and other cash payouts, thereby introducing potential agency conflicts. We also find that illiquidity and volatility are fundamentally entangled in their effects on asset prices. This aspect may help explain why some assets are viewed as inherently more liquid than others and why liquidity concerns are heightened during financial crises.
Keywords: No keywords provided
JEL Codes: G12; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| illiquidity (G33) | asset prices (G19) |
| immediacy (D84) | asset prices (G19) |
| illiquidity discounts (G33) | asset prices (G19) |
| illiquidity and volatility (G19) | asset prices (G19) |
| higher cash payouts (G35) | impact of illiquidity (G33) |