StatPro's
Approach to measuring Liquidity Risk
StatPro has designed an innovative approach to measuring market
liquidity risk that does not rely on observed bid, ask and volumes.
The approach breaks down liquidity risk into five components:
Fair Value Bid and Fair Value Ask
In this component we try to replicate the process that a
market-maker uses for creating bids and asks for fixed income
products and derivative instruments. We collect the information on
bid and asks for the underlying derivative instruments used by the
market-makers to hedge their risks and compute a fair value bid and
a fair value ask by inserting the respective bid and ask of the
underlying derivatives into our pricing functions. This process
takes into account the exposure of each instrument to each risk
factor. Therefore when creating a bid for a convertible bond, the
function will use the bid of the underlying implied volatility.
Instead, for the bid of a reverse convertible, the pricing
functions will receive as input the ask of the implied
volatility.
Pricing Function Type
Certain instruments have more liquidity risk than others simply
because of their nature. For example ABSs will be less liquid than
other bonds by definition.
Outstanding Nominal
The size of an issue is most relevant for the liquidity of a fixed
income instrument. Two identical bonds issued by the same issuer
can have more or less liquidity, depending on the size of the
issue. A $50m issue will be less liquid than a $1bn issue by
definition.
Market Cap (Equity Component)
In stocks the liquidity is intimately linked to the dimensions of a
company and to its market capitalization.
Percentage of Ownership (Equity
Component)
Given the idiosyncratic nature of individual stocks, the percentage
of the market capitalization of a stock owned by a certain
portfolio will be an essential driver of liquidity risk. Owning
0.0001% of a stock will not generate additional liquidity risk, but
owning 10% of the market cap will create a remarkable additional
liquidity risk to the owner.
To learn
more about our Liquidity Risk module contact us
today!
Back to
Liquidity Risk overview