The Quantification of Liquidity Premium Based on an Optimal Liquidation Strategy

A practical framework for the quantification of liquidity premium is proposed by designing an optimal liquidation strategy. That is, in a thin market, considering the market impact caused by the investors' own dealings, a rational investor adopts such optimal strategy as liquidating his position by steps to maximize his utility, which is different from the strategy under perfect liquidity market. According to the no-arbitrage principle, the liquidity premium can be calculated if the market is unbiased. It is found that it decreases with the increasement of the investment horizon, but the premium remains persistent while continuing to increase the horizon.