Estimating the Marketability Discounts: A Comparison between Bid-Ask Spreads, and Longstaff's Upper Bound

Journal of Applied Finance, Spring/Summer 2013, Volume 23, No. 1

Posted: 16 Jul 2013

See all articles by Niranjan Chipalkatti

Niranjan Chipalkatti

Seattle University - Albers School of Business and Economics

Carl F. Luft

DePaul University - Department of Finance

Lawrence Levine

Independent

Lummezen Mondal

Independent

Multiple version iconThere are 2 versions of this paper

Date Written: July 15, 2013

Abstract

This paper contends that the discount for lack of marketability (DLOM) is the difference between the stock price of a liquid company and an equivalent illiquid company and reflects the lack of a free-trading option that is embedded within a company’s stock. Longstaff derived a model that views this liquidity swap as a lookback option. We equate this option to the Bid-Ask spread of a stock consistent with the market microstructure literature. We construct a model for the DLOM using the Longstaff (1995) metric and the Bid-Ask spread of Over-the-Counter Bulletin Board stocks as a proxy. We find that our spread-based model does a better job of predicting restricted stock discounts than the Longstaff metric. We include a case study on two companies to illustrate our methodology.

Keywords: discount for lack of marketability (DLOM), lookback option, market microstructure, bid-ask spread

Suggested Citation

Chipalkatti, Niranjan and Luft, Carl F. and Levine, Lawrence and Mondal, Lummezen, Estimating the Marketability Discounts: A Comparison between Bid-Ask Spreads, and Longstaff's Upper Bound (July 15, 2013). Journal of Applied Finance, Spring/Summer 2013, Volume 23, No. 1 . Available at SSRN: https://ssrn.com/abstract=2294094

Niranjan Chipalkatti (Contact Author)

Seattle University - Albers School of Business and Economics ( email )

901 12th Avenue
Seattle, WA 98122
United States

Carl F. Luft

DePaul University - Department of Finance ( email )

1 East Jackson Blvd.
Chicago, IL 60604-2287
United States

Lawrence Levine

Independent ( email )

No Address Available

Lummezen Mondal

Independent ( email )

No Address Available

Register to save articles to
your library

Register

Paper statistics

Abstract Views
437
PlumX Metrics