Liquidity premium is a term used to explain a difference between two types of financial securities (e.g. stocks), that have all the same qualities except liquidity. For example:

Liquidity premium is a segment of a three-part theory

Theory

The English word theory was derived from a technical term in Ancient Greek philosophy. The word theoria, , meant "a looking at, viewing, beholding", and referring to contemplation or speculation, as opposed to action...

 that works to explain the behavior of yield curve

Yield curve

In finance, the yield curve is the relation between the interest rate and the time to maturity, known as the "term", of the debt for a given borrower in a given currency. For example, the U.S. dollar interest rates paid on U.S...

s for interest rates. The upwards-curving component of the interest yield can be explained by the liquidity premium. The reason behind this is that short term securities are less risky compared to long term rates due to the difference in maturity dates. Therefore investor

Investor

An investor is a party that makes an investment into one or more categories of assets --- equity, debt securities, real estate, currency, commodity, derivatives such as put and call options, etc...

s expect a premium, or risk premium for investing in the risky security. Liquidity risk premiums are recommended to be used with longer term investments, where those particular investments are illiquid.

or

Assets that are traded on an organized market are more liquid. Financial disclosure requirements are more stringent for quoted companies. For a given economic result, organized liquidity and transparency make the value of quoted share higher than the market value of an unquoted share. The difference in the prices of two assets, which are similar in all aspects except liquidity, is called the liquidity premium.