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Jump liquidity risk and its impact on CVaR

Author

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  • Harry Zheng
  • Yukun Shen

Abstract

Purpose - The aim is to study jump liquidity risk and its impact on risk measures: value at risk (VaR) and conditional VaR (CVaR). Design/methodology/approach - The liquidity discount factor is modelled with mean revision jump diffusion processes and the liquidity risk is integrated in the framework of VaR and CVaR. Findings - The standard VaR, CVaR, and the liquidity adjusted VaR can seriously underestimate the potential loss over a short holding period for rare jump liquidity events. A better risk measure is the liquidity adjusted CVaR which gives a more realistic loss estimation in the presence of the liquidity risk. An efficient Monte Carlo method is also suggested to find approximate VaR and CVaR of all percentiles with one set of samples from the loss distribution, which applies to portfolios of securities as well as single securities. Originality/value - The paper offers plausible stochastic processes to model liquidity risk.

Suggested Citation

  • Harry Zheng & Yukun Shen, 2008. "Jump liquidity risk and its impact on CVaR," Journal of Risk Finance, Emerald Group Publishing Limited, vol. 9(5), pages 477-492, November.
    • Handle: RePEc:eme:jrfpps:15265940810916139
    DOI: 10.1108/15265940810916139
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    Cited by:

    1. Sevcan Uzun & Ahmet Sensoy & Duc Khuong Nguyen, 2023. "Jump forecasting in foreign exchange markets: A high‐frequency analysis," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 42(3), pages 578-624, April.

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