arguesthattheeffectofchangesintransactionscostsonasset
prices is much smaller than estimated by Amihud and
Mendelsonbecauseinvestorsadjustholdingperiodstoreflect
transactionscosts.Infact,hearguesthatthepriceofastock
can actually increase as its transactions costs increase,
especiallyformorefrequentlytradedstocks;theincreasein
holding periods can offset the transactions costs increase.
20
Jarrowand Subramanian(2001)presentan alternate model
for estimating the illiquidity discount on value.
21 Theymodelthediscount asthedifferencebetween the
marketvalueofanasset anditsvaluewhenliquidatedand
argue that the discount should be larger when there are
execution lags in liquidation. They derive optimal trading
rules and the magnitude of the illiquidity discount for
investors with powerutilityfunctions. Lo,Mamaysky, and
Wang(2001)assume fixedtransactionscostsandconclude,
like Amihud and Mendelson, that small trading costs can
createsignificantilliquiditydiscountsandthatthesediscounts
are influenced heavily by the risk aversion of investors.
22
Insummary,thepapersthatdeveloptheoreticalmodelsfor
illiquidity discounts all link them to expected transactions
costs on assets but require investor holding periods as an
input for estimating the magnitude of the discount. The
discountforany giventransactions costswillbe smallerif
investorshavelongtimehorizonsthaniftheyhaveshorttime
horizons.
Illiquidity and Discount Rates