negativeand 1 ifpositive),cashasapercentoffirmvalue,
and trading volume.
Plugginginthecorrespondingvalues—withatradingvolume
ofzero—foraprivate firmshouldyieldan estimateofthe
syntheticbid-ask spreadfor thefirm.This syntheticspread
canbeusedasameasureoftheilliquiditydiscountonthe
firm.
Option-Based Discount
In anearlier section,we examinedan option-pricing-based
approach,whichallowedyoutoestimateanupperboundfor
theilliquiditydiscountbyassuminganinvestorwithperfect
market timing skills. There have been attempts to extend
optionpricingmodelstovalueilliquidity,withmixedresults.
Inone widelyusedvariation,liquidityismodeled asaput
option for the period when an investor is restricted from
trading.Thus,theilliquidity discountonvalue foranasset
wheretheownerisrestrictedfromtradingfortwoyearswill
be modeled as a two-year at-the-money put option.
68 There are several flaws, both intuitive and conceptual,
withthisapproach.Thefirstisthatliquiditydoesnotgiveyou
therighttosellastockattoday’smarketpriceanytimeover
thenexttwoyears.Whatitdoesgiveyouistherighttosellat
the prevailing market price anytime over the next two years.
69 Thesecond (andsmaller)problemisthatoptionpricing
models are based on continuous price movements and
arbitrage,anditisdifficulttoseehowtheseassumptionswill
hold up for an illiquid asset.