Cliff Asness challenges the conventional belief that illiquid assets should offer higher returns, arguing instead that extreme illiquidity may lead investors to accept lower expected returns in exchange for smoother, less visible volatility. The paper highlights how pricing opacity and behavioral biases drive demand, even if it means giving up return.
The Illiquidity Discount?
AQR
Cliff Asness
Research
4 Pages
Key Takeaways
Illiquidity Discount Exists: Investors may accept lower expected returns, with private equity potentially underperforming comparable public equities despite similar underlying risk exposures.
Volatility Masking Effect: During crises, reported drawdowns of ~25% in private equity versus ~60% in public proxies highlight how smoothing distorts perceived risk.
Behavior Drives Pricing: Investors may overpay for illiquid assets, effectively accepting a 0–2% lower expected return in exchange for reduced behavioral pressure and fewer mark-to-market shocks.
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