Analytical Bound on the Cost of Illiquidity for Equity Securities Subject to Sale Restrictions
Posted: 10 Aug 2012 Last revised: 29 Aug 2018
Date Written: May 1, 2010
We derive a theoretical upper bound for the cost of illiquidity to an undiversified investor whose entire wealth is committed to a single asset that is restricted from trading for a fixed time period. The analytical bound for the illiquidity discount is established using no-arbitrage principles and is applicable to a large class of models for asset price dynamics that admit option pricing functions with homogeneity of degree one with respect to the spot and strike prices. The model improves earlier bounds on restricted stock discounts established by Longstaff [1995a, b] without any loss of generality.
Keywords: marketability, liquidity, illiquidity, discount, restricted stock, private equity
JEL Classification: G12, G13
Suggested Citation: Suggested Citation