Forced Liquidations, Fire Sales, and the Cost of Illiquidity

Seeking diversification, institutional investors are often drawn to investment opportunities that are relatively illiquid, taking for granted that they will receive a liquidity premium that compensates them for the lack of liquidity. Forced liquidations typically occur when illiquid portfolios becom...

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Bibliographic Details
Published in:The journal of private equity 2016-12, Vol.20 (1), p.45-57
Main Authors: Lindsey, Richard R., Weisman, Andrew B.
Format: Article
Language:English
Subjects:
Cost estimates
Costs
Expected returns
Financial investments
Financial portfolios
Funding liquidity
Hedge funds
Institutional investments
Investment portfolios
Investors
Liquidation
Liquidity
Portfolio management
Private equity
Return on investment
Sales
Sovereign debt
Special Section
Statistical data
Valuation
Volatility
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Summary:Seeking diversification, institutional investors are often drawn to investment opportunities that are relatively illiquid, taking for granted that they will receive a liquidity premium that compensates them for the lack of liquidity. Forced liquidations typically occur when illiquid portfolios become overvalued relative to their true market value and the reported valuation is no longer credible. When a forced liquidation occurs, the significant associated costs are obvious and easy to take into account. But there is a rarely recognized cost that investors should apply to illiquid investments' expected return before such an event. This article presents a simple option-adjusted return for evaluating the cost of such illiquidity.
ISSN:1096-5572
2168-8508
DOI:10.3905/jpe.2016.20.1.045