Performance of Thinly Traded Assets: A Case in Real Estate

Abstract

AbstractThinly traded private assets do not fit into the traditional finance paradigm of a liquid and well‐functioning market where trading is continuous and instantaneous. Since private assets cannot be bought and sold easily, they bear liquidity risk. Classical finance theories cannot properly gauge the performance of illiquid private assets because they implicitly assume such illiquidity is trivial. This paper proposes an alternative performance metric for the illiquid private asset, which explicitly captures liquidity risk in a formal analysis. Applying the new performance metric, we are able to explain the decades‐old “real estate risk premium puzzle.”