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Liquidity premium is a term used to explain a difference between two types of financial securities (e.g. stocks), that have all the same qualities except liquidity. For example:
Liquidity premium is a segment of a three-part theory that works to explain the behavior of yield curves for interest rates. The upwards-curving component of the interest yield can be explained by the liquidity premium. The reason behind this is that short term securities are less risky compared to long term rates due to the difference in maturity dates. Therefore investors expect a premium, or risk premium for investing in the risky security. Liquidity risk premiums are recommended to be used with longer term investments, where those particular investments are illiquid.
Assets that are traded on an organized market are more liquid. Financial disclosure requirements are more stringent for quoted companies. For a given economic result, organized liquidity and transparency make the value of quoted share higher than the market value of an unquoted share. The difference in the prices of two assets, which are similar in all aspects except liquidity, is called the liquidity premium.
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