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Modeling Liquidity Risk With Implications for Traditional Market Risk Measurement and Management

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Author Info
Anil Bangia
Francis X. Diebold
Til Schuermann
John D. Stroughair

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Abstract

Market risk management traditionally has focussed on the distribution of portfolio value changes resulting from moves in the midpoint of bid and ask prices. Hence the market risk is really in a “pure” form: risk in an idealized market with no “friction” in obtaining the fair price. However, many markets possess an additional liquidity component that arises from a trader not realizing the mid-price when liquidating her position, but rather the mid-price minus the bid-ask spread. We argue that liquidity risk associated with the uncertainty of the spread, particularly for thinly traded or emerging market securities under adverse market conditions, is an important part of overall risk and is therefore an important component to model.

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Paper provided by New York University, Leonard N. Stern School of Business- in its series New York University, Leonard N. Stern School Finance Department Working Paper Seires with number 99-062.

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Date of creation: 21 Dec 1998
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Handle: RePEc:fth:nystfi:99-062

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Postal: U.S.A.; New York University, Leonard N. Stern School of Business, Department of Economics . 44 West 4th Street. New York, New York 10012-1126
Web page: http://w4.stern.nyu.edu/finance/
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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Darryll Hendricks, 1996. "Evaluation of value-at-risk models using historical data," Economic Policy Review, Federal Reserve Bank of New York, issue Apr, pages 39-69. [Downloadable!]
  2. Darryll Hendricks, 1996. "Evaluation of value-at-risk models using historical data," Proceedings, Federal Reserve Bank of Chicago, issue May, pages 334-362.
  3. Bertsimas, Dimitris & Lo, Andrew W., 1998. "Optimal control of execution costs," Journal of Financial Markets, Elsevier, vol. 1(1), pages 1-50, April. [Downloadable!] (restricted)
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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Stefano Benati & M. Tavernini, 1998. "A new lagrangean heuristic for the generalized assignment problem," Quaderni DISA 014, Department of Computer and Management Sciences, University of Trento, Italy.
  2. Michael G. Papaioannou, 2006. "A Primer for Risk Measurement of Bonded Debt from the Perspective of a Sovereign Debt Manager," IMF Working Papers 06/195, International Monetary Fund. [Downloadable!]
  3. Mark Carey & Rene M. Stulz, 2005. "The Risks of Financial Institutions," NBER Working Papers 11442, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Robert Engle & Robert Ferstenberg, 2006. "Execution Risk," NBER Working Papers 12165, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  5. Christian A. Johnson, 2002. "Value at Risk: Teoría y Aplicaciones," Working Papers Central Bank of Chile 136, Central Bank of Chile. [Downloadable!]
  6. Pierre Giot & Joachim Grammig, 2006. "How large is liquidity risk in an automated auction market?," Empirical Economics, Springer, vol. 30(4), pages 867-887, January. [Downloadable!] (restricted)
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  7. Carey, Mark & Stulz, Rene M., 2005. "The Risks of Financial Institutions," Working Paper Series 2005-13, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
  8. Luca Erzegovesi, 2002. "VaR and Liquidity Risk.Impact on Market Behaviour and Measurement Issues," Alea Tech Reports 014, Department of Computer and Management Sciences, University of Trento, Italy, revised 14 Jun 2008. [Downloadable!]
  9. Timotheos Angelidis & Alexandros Benos, . "The Components of the Bid-Ask Spread: The case of the Athens Stock Exchange," Working Papers 0615, University of Crete, Department of Economics. [Downloadable!]
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