As one can see from Table 3, the relationship between desired (or preexisting) equity holdings, and the demanded liquidity premium
resembles an inverted parabola, and is zero at both ends.
It is possible to use the liquidity-premium spread to adjust the breakeven inflation compensation for movements in the liquidity premium
Vila (1999): "Equilibrium interest rates and liquidity premium
with transaction costs", Economic Theory, 13, pp.
Our interpretation of this evidence is that as the liquidity premium
in expected returns decreases, there is an increase in investment opportunities at the margin, and the set of viable investment opportunities expands.
Failure to adjust for a liquidity premium
would represent a major flaw in an appraisal report on a company without equity and that is actively traded in the market.
less the liquidity premium
for the inflation-protected security of the same maturity of m months.
In practice, he set the liquidity premium
equal to 60 basis points, which was the average spread between the short-term market rate and a 10-year government bond rate.
However, we interpret univariate tests and visual evidence with caution, because other factors could offset an increase in the liquidity premium
that occurs between the two periods.
Chapter 7 Unlocking the liquidity premium
in collateral swaps
Investors can take advantage of situations where a security's liquidity premium
or discount runs counter to their assessment of the underlying value.
A well-known principle of finance is that today's long rates are just expected future short rates plus a liquidity premium
A 15% drop in liquidity, for example, would mean a relatively minor increase of five basis points in the liquidity premium
on AAA-rated bonds, but a 116-basis-point jump in the premium for high-yield bonds.