A “liquidity premium” compensates investors for lower market liquidity. The St. Louis Fed illustrates it with a liquidity spread between assets matched on maturity and safety but differing in liquidity.
ReviewedEvidence1 sourceSectionPhrases & Idioms
Quick answer
A liquidity premium is extra compensation associated with holding a less-liquid asset rather than an otherwise comparable more-liquid asset.
Key details
Canonical Formliquidity premium
Core MeaningA liquidity premium is extra compensation associated with holding a less-liquid asset rather than an otherwise comparable more-liquid asset.
Further guidance
History Boundary
Current authoritative financial meaning is published without claiming an exact inventor, coinage date, or absolute first use.
Meaning
A liquidity premium is extra compensation associated with holding a less-liquid asset rather than an otherwise comparable more-liquid asset.
Usage Boundary
Observed yield differences can also reflect maturity, safety, credit, tax, or other factors; the clean liquidity interpretation requires an otherwise comparable benchmark.
Sources and evidence
Sources are shown with the role they play in this guide. Historical or style-sensitive claims are kept within the evidence boundary described above.
The Federal Reserve measure called the excess bond premium is the residual component of corporate bond spreads after accounting for expected default losses and is used as a gauge of bond-investor risk sentiment. This is a model-based Federal Reserve measure, not a synonym for the entire credit spread and not a universally fixed formula across all research settings.
Funding liquidity is the ability of a financial institution or market participant to obtain cash funding, including through secured or unsecured borrowing. Funding liquidity concerns the ability to raise cash funding; it is distinct from market liquidity, which concerns trading assets without large price effects, though the two can interact.
A “liquidity crunch” is a period when cash or readily available funding becomes scarce and normal borrowing, trading, or payment needs become harder to meet. A liquidity crunch is not automatically the same as insolvency or a credit crunch, although severe liquidity stress can interact with solvency concerns and tighter credit conditions.
Liquidity risk is the risk that liquidity becomes impaired when an asset must be traded or funding needs must be met; authoritative frameworks distinguish market-liquidity risk from funding-liquidity risk. Use the broad label with care: market-liquidity risk concerns difficulty exiting or offsetting positions near market prices, while funding-liquidity risk concerns meeting cash-flow and collateral needs.
Market liquidity concerns the cost and time required to buy or sell an asset for cash, including how much trading moves its price. Market liquidity concerns trading assets; it is distinct from funding liquidity, which concerns the ability to raise cash funding, although the two can interact.
Under current U.S. Regulation NMS, “orders providing liquidity” are orders that were executed against after resting at a trading center. Use this term in the precise § 242.600 market-quality/reporting context; “providing liquidity” here is a defined order classification, not a general statement about every resting order.
Under current U.S. Regulation NMS, “orders removing liquidity” are orders that executed against resting trading interest at a trading center. Use this term in the precise § 242.600 market-quality/reporting context; “removing liquidity” here is a defined order classification, not a generic description detached from the rule.
A “risk premium” is the additional expected return investors require as compensation for bearing risk relative to a safer benchmark. The specific premium depends on the asset and risk being measured, and many risk premiums are estimated rather than directly observed.
