What Is Illiquid?

Illiquid refers to a stock, bond, or another asset that cannot be sold or exchanged for cash without suffering a significant loss in value. Illiquid assets can be difficult to sell rapidly due to limited trading activity or interest in the issue, as evidenced by a scarcity of ready and willing buyers or speculators to buy or sell the asset. Illiquid assets have smaller trading volumes, larger bid-ask spreads, and higher price volatility as a result.

The polar opposite of liquidity is illiquidity.

• When security or another asset cannot be easily and rapidly sold or exchanged for cash without suffering a significant loss in value, it is said to be illiquid.

• Due to a lack of ready and willing investors or speculators to purchase the asset, illiquid assets may be difficult to sell fast, whereas actively traded securities will be more liquid.

• Illiquid assets offer bigger bid-ask spreads, more volatility, and thus a higher risk for investors.

Illiquidity Explained

In the case of illiquid assets, the lack of ready buyers leads to bigger price differences between the seller's asking price and the buyer's offer price. Because of this discrepancy, bid-ask spreads are substantially wider than they would be in a well-ordered market with everyday trading activity. Holders of illiquid assets may suffer losses due to a lack of depth of market (DOM), or ready buyers, especially if they are attempting to sell rapidly.

In the context of a business, illiquidity refers to a corporation that lacks the cash flows essential to meet its debt obligations, but it does not imply that the organization is without assets. Real estate and production equipment are examples of capital assets that have value but are difficult to sell when cash is needed. It is not a company's fundamental business to sell illiquid assets. They usually refer to any of the company's assets that aren't related to the things it produces for sale. In times of crisis, a firm may need to liquidate these assets to avoid bankruptcy, and if it does so rapidly enough, it can sell them at prices significantly below an orderly fair market price, which is known as a fire sale.

A corporation may also become illiquid if it is unable to secure the funds required to pay its debt obligations.

Illiquid and Liquid Assets Examples

Houses and other real estate, cars, antiques, private company interests, and some types of debt instruments are all instances of intrinsically illiquid assets. Collectibles and works of art are frequently illiquid assets.

Stocks traded on over-the-counter (OTC) markets are frequently less liquid than those traded on well-established exchanges. Despite the fact that these assets may have intrinsic worth, the market in which they are sold frequently has a smaller number of purchasers than the market for more liquid assets.

On the other hand, most listed securities traded on major exchanges, such as stocks, ETFs, mutual funds, bonds, and listed commodities, are extremely liquid and may be sold at a fair market price nearly instantly during regular market hours. Furthermore, precious metals like gold and silver are frequently liquid. Trading outside of typical business hours might lead to illiquidity because many market players are not present during those hours.

The liquidity of an asset might alter over time as a result of external market pressures. This is especially true for collectibles, as the popularity of an item in the consumer market can fluctuate rapidly, resulting in very fluctuating costs.

Increased Risk Due to Lack of Liquidity

Liquidity risk is higher in illiquid securities than in liquid securities, which is especially true during market upheaval when the buyer-to-seller ratio is pushed out of balance. Holders of illiquid securities may find themselves unable to unload them at all, or at least unable to do so without losing money, during these periods.

Illiquid securities may also require a liquidity premium to compensate for the fact that they may be difficult to sell in the future. Markets and credit facilities may freeze up during times of financial panic, resulting in a liquidity crisis in which sellers of even marketable securities find it difficult to find interested purchasers at reasonable rates.

Example from the Real World

Companies and people alike may find themselves unable to pay their debts due to illiquidity. Jet Airways, for example, has delayed repayment of overseas debt for the fourth time "in recent months" due to a corporate illiquidity situation that has left the company unable to access liquid funds, according to The Economic Times. As a result, Jet Airways had to halt more than 80 planes and put together a resolution plan that included the resignation of its chairman, Naresh Goyal, and a vote by the board to allow lenders to assume control of the airline.