MARKET LIQUIDITY RISK: A SCENARIO BASED APPROACH
Dario Cintioli, Head of Risk, StatPro
This paper explains the StatPro approach for
measuring Liquidity Risk. The traditional problem of Liquidity Risk
is that the data needed for calibrating these models is only
available for liquid instruments, trading on a regular basis and
for which books of bid/ask and volumes are available. For this
reason the current approaches to measuring Liquidity Risk fail
providing any indication for the most opaque and illiquid
instruments, or where the measurement of Liquidity Risk is mostly
needed.
StatPro has introduced a new approach
based on liquidity scenarios, which is universal, because it covers
potentially any financial asset, from equities, to bonds, to OTC
derivatives under a homogeneous and consistent approach.
The Liquidity Risk measure is divided into
six different components. The most important component re-builds,
with a quantitative approach based on observed market data, the
fair value bid and asks of all the financial instruments that can
be priced via an arbitrage-free pricing function, providing a solid
and consistent benchmark of Liquidity Risk.
Market Liquidity
Risk
What is Liquidity Risk? We can provide at
least two definitions for it.
Funding Liquidity Risk. This
definition refers to the Asset Liability Management (ALM) of an
institution – normally a bank – identifying the gaps in the funding
of the institution’s assets. E.g. in a bank there is usually a
funding gap as the liabilities contain short-term deposits in large
part against assets that invest in longer term horizons. Funding
gaps generate a funding risk, the risk of rolling the short term
funding at growing costs or even the risk of not being able to
roll/over the shorter term liabilities.
Market Liquidity Risk. This is the
risk of losing a certain amount of money when liquidating one or
more positions in a portfolio. In financial terms, the loss is
generated by the difference between the price at which the
financial asset is marked and the price at which it can be
sold.
This paper focuses on Market Liquidity
Risk.
To download the full 9-page whitepaper
on Market Liquidity Risk please
click
here
Read more about StatPro's
Liquidity Risk module or download the
Liquidity Risk factsheet
back to
Whitepapers