Damodaran on Valuation

14.1. MEASURING ILLIQUIDITY

You can sell any asset, no matter how illiquid it is perceived to be, if you are willing to accept a lower price for it. Consequently, we should not categorize assets into liquid and illiquid assets but allow for a continuum on liquidity, where all assets are illiquid but the degree of illiquidity varies across them. One way of capturing the cost of illiquidity is through transactions costs, with less liquid assets bearing higher transactions costs (as a percent of asset value) than more liquid assets. In this section, we consider the components of transactions costs for publicly traded assets first and then extend the analysis to cover nontraded assets.

14.1.1. Transactions Costs on Publicly Traded Assets

There are some investors who undoubtedly operate under the misconception that the only cost of trading is the brokerage commission that they pay when they buy or sell assets. While this might be the only cost that they pay explicitly, there are other costs that they incur in the course of trading that generally dwarf the commission cost. When trading any asset, they are three other ingredients that go into the trading costs. The first is the spread between the price at which you can buy an asset (the dealer's ask price) and the price at which you can sell the same asset at the same point in time (the dealer's bid price). The second is the price impact that an investor can create by trading on an asset, pushing the price up when buying the asset and ...