periods. Using data from 1984–2004, Venture
Economics estimated that the returns to venture
capital investors havebeen about 4 percent higher
than the returns on traded stocks.
73 Wecouldattributethisdifferencetoilliquidityand
add itonas theilliquidity premiumfor allprivate
companies.Thekey isto avoiddoublecountingthecost ofilliquidity
sincesomeofthesmallstockpremiummaybecompensation
for the illiquidity of small-cap companies.
- Add a firm-specific illiquidity premium, reflecting the
illiquidityoftheassetbeingvalued.Forliquiditypremiums
thatvaryacrosscompanies,wehavetoestimateameasureof
howexposedcompaniesaretoliquidityrisk.Inotherwords,
we need liquidity betas or their equivalent for individual
companies.Drawingontheworkdoneontheliquidity-based
capitalassetpricingmodel,theseliquiditybetasshouldreflect
notonlythemagnitudeoftradingvolumeonaninvestment
but also how that trading volume varies with the market
tradingvolumeovertime.Itmaybepossible todothis for
some real assets (such as real estate) where there are
transactionsfromtimetotime,butitmaybeimpossibletodo
for unique private businesses.
3.Relatetheobservedilliquiditypremiumontradedassetsto
specificcharacteristicsofthose assets.Thushealthierfirms
with moreliquid holdingsshouldhavea smallerilliquidity
premiumaddedtothediscountratethandistressedfirmswith
nonmarketableassets.Whilethiscanbedonesubjectively,it
wouldmakemoresensetohaveasolidquantitativebasisfor
the adjustment.