R22.
\rant/
When we say ‘liquidity premium’, should it be a measure of how illiquid a security is? (Looks like it is the case, and that’s a deceptive nomenclature)
(I would think illiquidity premium should make a security attract a higher yield and liquidity premium a higher premium in terms of price.)
They are the same thing I believe, I looked this up a few months ago as I had a mental blank once I started hitting the books
No, they aren’t the same.
Liquidity premium is the additional return you expect for taking on a security that is illiquid. It’s not really a measure of illiquidity (you’d use trading volume or bid-ask spread to measure illiquidity), but rather the incremental reward for holding something that is illiquid.
It’s kind of like “Credit Risk”, which measures the lack of or deterioration of credit. No one calls it “Discredit Risk”, if that makes sense.
By the same token, there are lack of marketability, lack of control, lack of liquidity discounts too.
Let’s put in a different way. Liquidity premium is the additional return you’ll want to buy something that is illiquid.
Lack of liquidity is a discount that you’ll want when you buy something that is illiquid.
When you buy something at a discount, you get an extra return, which is what you get at a liquidity premium. Ergo, they are same thing, put in a different way. Illiquidity Discount vs Liquidity Premium. One is from the return perspective, the other from the cost to purchase perspective.
its always illiquidity premium. there is no liquidity premium
Let me put an end to this - the word is “liquidity risk” which translates to an investor earning a premium for iliquidity. It’s that simple.
I learned this as a sophomore in college really.
I can still vividly remember watching my teacher (she was PhD - uber smart professor) write on the board R + I + C + L + M … it’s stuck with me apparantly.
edit: Wait, I may have been a junior when we learned this. I can’t really remember. . . was pretty drunk all four years #yolo