Damodaran on Valuation

Chapter 14. The Value of Liquidity

When you buy a stock, bond, real asset, or business, you sometimes face buyer's remorse, where you want to reverse your decision and sell what you just bought. The cost of illiquidity is the cost of this remorse. In the case of publicly traded stock in a heavily traded company, this cost should be small. It will be larger for stock in a small, over-the-counter stock and will escalate for a private business, where there are relatively few potential buyers. It can also vary for different types of assets, with higher costs for real assets and lower costs for financial assets. In this chapter, we examine the reasons why investors value liquidity and the empirical evidence on how much they value it. We follow up by looking at how the perceived liquidity or illiquidity of an asset affects the price you would be willing to pay for it and how best to incorporate illiquidity into valuations.