How to Calculate Liquidity Premium and Real Risk

By Motley Fool Staff – Updated Apr 29, 2025 at 10:53 PM EST

Key Points

Investors demand higher returns from illiquid assets due to greater selling difficulty.
Liquidity premium can be calculated by comparing yields of similar liquid and illiquid bonds.
Real risk-free rate equals Treasury bond yield minus current inflation rate.

Investing is about putting money at risk to earn a return. In theory, the more risk an investor is willing to accept, the more returns he or she should expect to earn to compensate for the risk.

Two metrics to quantify how the market is valuing risks and rewards are liquidity premiums and the real risk-free rate. In this post, we'll break down each.

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Street signs saying Risk and Reward. — Image source: Getty Images.

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To calculate the real risk-free rate, subtract the current inflation rate from the Treasury bond yield that matches your investment duration. If, for example, the 10-year Treasury bond yields 2%, investors would consider 2% to be the risk-free rate of return. Treasury bonds are the most often cited proxy for the risk-free rate because they are backed by the full faith and credit of the U.S. government.

If inflation stands at 0.5%, then the real risk-free rate would be 1.5%: The risk-free rate of 2% minus 0.5% inflation equals 1.5%.

In practice, this 1.5% real risk-free rate is the rate that investors expect to earn after inflation from a risk-free investment with a 10-year duration after inflation.

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