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

14 Pages Posted: 12 Nov 2015

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 M. Levine

affiliation not provided to SSRN

Lummezen Mondal

affiliation not provided to SSRN

Multiple version iconThere are 2 versions of this paper

Date Written: November 5, 2015

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.

Suggested Citation

Chipalkatti, Niranjan and Luft, Carl F. and Levine, Lawrence M. and Mondal, Lummezen, Estimating the Marketability Discounts: A Comparison between Bid-Ask Spreads, and Longstaff's Upper Bound (November 5, 2015). Journal of Applied Finance (Formerly Financial Practice and Education), Vol. 23, No. 1, 2013. Available at SSRN: https://ssrn.com/abstract=2686744

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 M. Levine

affiliation not provided to SSRN

Lummezen Mondal

affiliation not provided to SSRN

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