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A Note on fair Value and Illiquid Markets

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  • Dominique Guegan

    (CES - Centre d'économie de la Sorbonne - UP1 - Université Paris 1 Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique, PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École des Ponts ParisTech - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

  • Chafic Merhy

    (Natixis Asset Management - SAMS)

Abstract

We present in this paper a method to extract fair prices from observable prices in an illiquid market. The dynamics of fair prices have a general form encompassing random walks. In fact, only a part of a movement in price is assumed to reflect fundamental changes, the rest is considered to be friction. That part is optimally estimated by a Kalman filter". The model allows also to recover liquidity premia as a product of innovations times an illiquidity multiplier. Thus the higher the difference between observed and filtered prices (prices obtained under "normal" market dynamics), the higher liquidity premium will be. The model can be adapted to various kind of instruments and calibrated in different ways.

Suggested Citation

  • Dominique Guegan & Chafic Merhy, 2010. "A Note on fair Value and Illiquid Markets," Post-Print halshs-00460856, HAL.
    • Handle: RePEc:hal:journl:halshs-00460856
    Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00460856
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    References listed on IDEAS

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    1. Guillermo Llorente & Roni Michaely & Gideon Saar & Jiang Wang, 2002. "Dynamic Volume-Return Relation of Individual Stocks," The Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1005-1047.
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    4. Harris, Lawrence, 1990. "Statistical Properties of the Roll Serial Covariance Bid/Ask Spread Estimator," Journal of Finance, American Finance Association, vol. 45(2), pages 579-590, June.
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