@article {Chen07, author = {Ren-Raw Chen and Bo Li}, title = {A Closed-Form Solution to the Liquidity Discount Problem: With an Application to the Liquidity Crisis }, volume = {25}, number = {2}, pages = {07--24}, year = {2015}, doi = {10.3905/jfi.2015.25.2.007}, publisher = {Institutional Investor Journals Umbrella}, abstract = {During the recent financial crisis, we witnessed unprecedented compressions of asset prices. In a recent paper, Chen [2012] proposed a liquidity discount model that can successfully explain large price falls. In this article, we provide alternative valuations to the Chen model. Building on the same framework, we provide a new polynomial representation of the liquidity discount. We also simplify the Chen model to a closed-form solution in a situation where there is no trading in the marketplace. We demonstrate in analytical forms that convexity in a security payoff is absolutely positively related to liquidity discounts.Finally, we contribute to the literature in relating the Chen model to trading volume (e.g., Karpoff [1986, 1987]). Using the price and trading volume data of the nine largest financial firms in the United States, we find strong support of the Chen model.TOPICS: Security analysis and valuation, quantitative methods}, issn = {1059-8596}, URL = {https://jfi.pm-research.com/content/25/2/07}, eprint = {https://jfi.pm-research.com/content/25/2/07.full.pdf}, journal = {The Journal of Fixed Income} }