Paying For Illiquidity

Byrne Hobart
10 min readApr 17, 2019

One of the few boneheadedly obvious things financial theory tells us is that an asset is worth more if you can immediately convert it into cash. A CD maturing in a year is worth a discount to face value; an illiquid bond maturing in a decade is worth less; a minority shareholding in a small company is worth even less.

Fortunately for anyone who gets paid to explain this stuff for a living, the terminology is hopelessly confused. As one of my CFA workbooks pointed out, the two terms people use for the extra return investors demand in exchange for their money being locked up are “illiquidity premium” and “liquidity premium.” Nice.

This is especially confusing because there’s a certain category of investors who actually want illiquidity, and inasumch as investor preferences are expressed by the returns they accept, they’ll pay a premium for assets that are harder to sell. This flies in the face of financial theory, but the institutional logic behind it is sound — for the asset allocators, not the people they’re allocating on behalf of.

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Byrne Hobart
Byrne Hobart

Written by Byrne Hobart

I write about technology (more logos than techne) and economics. Newsletter: https://diff.substack.com/