Illiquidity refers to a situation where an asset cannot be quickly sold or exchanged for cash without causing a significant drop in its price. In simple terms, it means there are few buyers and sellers in the market, making it difficult to trade the asset at a fair value. Illiquidity can exist in various financial instruments such as stocks, bonds, real estate, or private equity investments.

In the financial markets, liquidity is a measure of how easily assets can be converted into cash. When this ease of conversion is low, the market or asset is termed illiquid. For instance, shares of small or lesser-known companies often experience illiquidity because they have lower trading volumes compared to large, actively traded stocks. Similarly, assets like real estate or collectibles are inherently less liquid since selling them takes time and effort.

Illiquidity poses several risks for investors. It may lead to higher price volatility, difficulty in exiting positions, and potentially lower realized value when selling under pressure. During periods of market stress, illiquid assets tend to decline faster in value as buyers disappear and sellers are forced to accept lower prices. Hence, investors must account for liquidity risk while constructing their portfolios.

To manage illiquidity, investors often prefer assets with high trading volumes and narrow bid-ask spreads. Portfolio diversification across liquid and illiquid instruments can also help balance potential returns with accessibility. Regulatory bodies like SEBI encourage transparency and disclosure in illiquid markets to protect investors and maintain market stability.

In essence, understanding illiquidity is crucial for effective financial planning and risk management. It helps investors make informed decisions, especially when evaluating long-term or alternative investments where immediate cash conversion may not be feasible.