Valuing Thinly-Traded Assets
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.
Francis A. Longstaff is with the UCLA Anderson School and the NBER, and is a consultant to Blackrock. I am grateful for helpful discussions with Maureen Chakraborty and Stephen Schurman. All errors are my responsibility. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.