What method can be used to estimate the amount of an illiquidity premium?

The multiperiod Sharpe ratio is a robust method for estimating the illiquidity premium because it accounts for the return over multiple periods relative to the risk taken. This approach allows for the assessment of the risk-adjusted performance of an investment over a significant timeframe, which is crucial for assets that may exhibit illiquidity.

In financial markets, illiquid assets may provide higher returns to compensate for the inability to sell them quickly without affecting their price. By examining the multiperiod Sharpe ratio, investors can gauge the performance of illiquid investments across market cycles and longer durations, helping them quantify the additional return required for taking on the liquidity risk.

In contrast, other methods such as the single period Sharpe ratio may not adequately capture the complexities of longer-term investments, while averaging historical returns can overlook the specific risks associated with liquidity. Risk-free rate analysis focuses on evaluating returns without the liquidity factor, thereby failing to address the illiquidity premium specifically.