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Economic and Market Commentary

Liquidity, Complexity and Scale in Private Markets

  • This paper investigates models of illiquidity and summarizes their salient conclusions.
  • The illiquidity premium can be partially explained by transaction costs and investment horizons. Patient investors may get rewarded with higher premia.
  • The premium can be explained by liquidity patterns: For example, the more an asset’s liquidity covaries with market returns, the higher the illiquidity premium. 
  • The premium can also be attributed to the inability to trade the asset at a favorable price during a lockup or illiquidity window.
  • Importantly, illiquidity and complexity are not independent but, rather, related by the fact that complex investments often trade at lower frequencies. This means that the price discovery process cannot reliably look to past prices as an indication of fair value.
  • Hence, a feedback mechanism exists in which complexity leads to illiquidity, which, in turn, creates complexity. Ultimately, the set of investors who possess both the necessary patience and the scale to undertake private market investments is limited.

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