What is the illiquidity premium?
A primer on the rewards and hazards of investing in hard-to-trade assets
IMAGINE TWO bonds listed on different exchanges that are otherwise identical. The risk-free rate of return is 2%. Investors hold bonds for an average of one year. A central bank acts as market-maker, supplying cash on demand for bonds. To cover its costs, the price the central bank pays (the bid) is a bit below the fair value of a bond, which is the price it requires buyers to pay for it (the ask). The bid-ask spread is the cost of trading. For A-bonds it is 1%. For B-bonds, which are listed on an inefficient exchange that charges higher fees, it is 4%.
This article appeared in the Finance & economics section of the print edition under the headline “Against the flow”
Finance & economics November 9th 2019
- Revisiting the euro’s north-south rift
- China tries to squeeze more out of a small trade deal with America
- Distressed debt funds are waiting for a downturn
- Have billionaires accumulated their wealth illegitimately?
- What is the illiquidity premium?
- Mexico’s radical president serves up economic mediocrity
- Financial crime through video games is on the rise
- Litigation finance faces ethical quandaries
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