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Jump liquidity risk and its impact on CVaR

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  • Harry Zheng
  • Yukun Shen
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    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.

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    Bibliographic Info

    Article provided by Emerald Group Publishing in its journal Journal of Risk Finance.

    Volume (Year): 9 (2008)
    Issue (Month): 5 (November)
    Pages: 477-492

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    Handle: RePEc:eme:jrfpps:v:9:y:2008:i:5:p:477-492

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    Related research

    Keywords: Liquidity; Monte Carlo methods; Risk analysis;

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    Cited by:
    1. Ahmed Arif & Ahmed Nauman Anees, 2012. "Liquidity risk and performance of banking system," Journal of Financial Regulation and Compliance, Emerald Group Publishing, vol. 20(2), pages 182-195, May.
    2. Jan Hanousek & Evžen Kočenda & Jan Novotný, 2013. "Price Jumps on European Stock Markets," William Davidson Institute Working Papers Series wp1059, William Davidson Institute at the University of Michigan.
    3. Jan Willem van den End & Mark Kruidhof, 2012. "Modelling the liquidity ratio as macroprudential instrument," DNB Working Papers 342, Netherlands Central Bank, Research Department.

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