illiquidity, smaller and more distressed companies
(whichtendtotradeatlowprice-to-bookratios)are
more illiquid than the rest of the market.The interplay between illiquidity and so many observed
inefficienciesinthemarketsuggeststhatilliquidity playsa
keyroleinhowinvestorspricestocksandthereturnsthatwe
observeintheaftermath.Itmayalsoexplainwhythereareso
manywaysofmakingexcessreturnsonpaperandsofewin
practice.
Controlled Differences
Studiesthatcomparestockswithdifferentdegreesofliquidity
canalways be faultedfor notcontrollingfor otherfactors.
After all, companies with moreliquid stockstend to have
largermarketcapitalizationandlowerrisk.Consequently,the
cleanesttestsforilliquidityarethosethatcomparestockswith
different degreesofliquidityissuedby thesamecompany.
Differencesinstock pricescanthenbeattributedpurelyto
liquidity.
Restricted Stock and Private Placements
Much ofthe evidenceon illiquidity discounts comesfrom
examiningrestricted stockissued by publicly tradedfirms.
Restrictedsecuritiesaresecuritiesissuedbyapubliclytraded
company, not registered with the Securities and Exchange
Commission(SEC),andsoldthroughprivateplacementsto
investorsunderSECRule144.Theycannotberesoldinthe
open market for a one-year holding period,
46 andonlylimitedamountscanbesoldafterthat.Whenthis
stock isissued, theissueprice isset muchlower thanthe