Estimating the Marketability Discounts: A Comparison between Bid-Ask Spreads, and Longstaff's Upper Bound
14 Pages Posted: 12 Nov 2015
Date Written: November 5, 2015
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.
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