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Liquidity Premium Formula:
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Liquidity premium represents the additional return investors require for holding less liquid assets compared to more liquid alternatives. In mutual funds, it measures the extra yield investors receive for accepting lower liquidity.
The calculator uses the liquidity premium formula:
Where:
Explanation: The formula calculates the difference in yield between an illiquid asset and a comparable liquid asset, representing the compensation investors receive for reduced liquidity.
Details: Calculating liquidity premium helps investors evaluate whether the additional return from less liquid investments adequately compensates for the reduced liquidity risk. It's crucial for portfolio construction and risk management decisions.
Tips: Enter both yield values as percentages. The illiquid yield should be from the less liquid investment, and the liquid yield should be from a comparable but more liquid benchmark. Both values must be non-negative.
Q1: What is considered a good liquidity premium?
A: A positive liquidity premium indicates compensation for illiquidity. The adequacy depends on investment horizon, risk tolerance, and market conditions.
Q2: How does liquidity premium vary across asset classes?
A: Liquidity premium tends to be higher for less liquid assets like real estate, private equity, and certain bonds compared to highly liquid stocks.
Q3: Does liquidity premium change over time?
A: Yes, liquidity premium fluctuates with market conditions, typically increasing during financial crises when liquidity becomes scarce.
Q4: How is this different from illiquidity discount?
A: Liquidity premium and illiquidity discount are two sides of the same concept - one focuses on the extra return, the other on the price discount.
Q5: Should liquidity premium be annualized?
A: For accurate comparison, ensure both yields are measured over the same time period, typically annualized for consistency.