The liquidity premium in illiquid asset classes

Illiquid assets play an increasing role in institutional investors’ portfolios, even though recent empirical studies have challenged the conventional wisdom of liquidity level premiums for these asset classes. Solving a model that captures both possible transactions costs and infrequencies of trading opportunities for illiquid assets, we show that short-term investors or investors that face substantial liquidity shocks demand a sizable liquidity premium. We model heterogeneous agents for four different asset classes (private equity, real estate, corporate bonds, and stocks) to explain the empirically observed differences in liquidity premiums using clientele effects. We find an average annual liquidity premium of 45 basis points for private equity, 65 basis points for real estate, 30 basis points for corporate bonds and 40 basis points for stocks.