What’s Illiquid?

Stocks, bonds, and other assets that cannot be sold or exchanged for cash without a significant loss are illiquid. Illiquid assets may be hard to sell rapidly due to minimal trading activity or interest from investors or speculators. Illiquid assets have smaller trading volume, larger bid-ask spreads, and more price volatility.

Illiquidity is the antithesis of liquidity.

Illiquidity Explained

Lack of available buyers increases differences between seller-set asking price and buyer-submitted bid price for illiquid assets. This discrepancy results in wider bid-ask spreads than in a structured market with daily trading. Illiquid asset holders might lose money due to a lack of depth of market (DOM), or available buyers, particularly if they want to sell rapidly.

In business, illiquidity refers to a corporation lacking the requisite cash flows to fulfill its debts, but not necessarily lacking assets.Capital assets like real estate and manufacturing equipment are valuable yet hard to sell for cash. Illiquid asset sales are not a company’s main activity. The company’s non-product property is usually included. During a crisis, a corporation may sell assets too hastily to avoid bankruptcy, leading to fire sales at prices below fair market value.

A corporation may become illiquid if it cannot get funds to pay debts.

Examples of Liquid and Illiquid Assets

Examples of illiquid assets include real estate, vehicles, antiques, private business interests, and debt instruments. Illiquid items include collectibles and art.

Many OTC stocks are less liquid than those listed on strong exchanges. They may have value, but the market for these assets is frequently less active than for more liquid assets.

On the other hand, listed assets like stocks, ETFs, mutual funds, bonds, and commodities are highly liquid and may be sold quickly at fair market prices during normal market hours. In addition, gold and silver are typically liquid. Trading after business hours may also produce illiquidity since many market players are inactive.

Market forces may impact an asset’s liquidity. Collectibles’ prices are extremely unpredictable since their popularity may shift drastically.

Low liquidity, high risk

For illiquid assets, liquidity risk is greater than for liquid ones, particularly during market volatility when buyers outnumber sellers. Illiquid securities holders may be unable to sell them or lose money at these periods.

To account for potential difficulties in disposal, illiquid securities may need a premium on their price. In times of financial panic, markets and credit facilities may freeze, leading to a liquidity crisis as sellers struggle to find buyers at fair prices for marketable securities.

Real-World Example

Illiquidity may prevent corporations and people from paying their obligations. For instance, The Economic Times reported that Jet Airways has postponed international debt payments for four times in recent months owing to a corporate illiquidity issue, preventing access to liquid money. Jet Airways grounded over 80 flights and implemented a resolution plan requiring Naresh Goyal’s resignation and board approval for lenders to take over the company.

Economic Times. “Jet Airways delays ECB repayment amid liquidity crunch.” Accessible Aug. 28, 2020.

CONCLUSION

• An illiquid investment or asset cannot be sold or exchanged for cash without a significant loss in value.
• It may be hard to sell rapidly due to a lack of prospective purchasers or speculators, whereas actively traded securities are more liquid.
• Investor risk increases with illiquid assets’ bigger bid-ask spreads, volatility, and risk.