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Measuring market liquidity risk - which model works best?

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  • Ernst, Cornelia
  • Stange, Sebastian
  • Kaserer, Christoph

Abstract

Market liquidity risk, the difficulty or cost of trading assets in crises, has been recognized as an important factor in risk management. Literature has already proposed several models to include liquidity risk in the standard Value-at-Risk framework. While theoretical comparisons between those models have been conducted, their empirical performance has never been benchmarked. This paper performs comparative back-tests of daily risk forecasts for a large selection of traceable liquidity risk models. In a 5.5 year stock sample we show which model provides most accurate results and provide detailed recommendations which model is most suitable in a specific situation.

Suggested Citation

  • Ernst, Cornelia & Stange, Sebastian & Kaserer, Christoph, 2009. "Measuring market liquidity risk - which model works best?," CEFS Working Paper Series 2009-01, Technische Universität München (TUM), Center for Entrepreneurial and Financial Studies (CEFS).
    • Handle: RePEc:zbw:cefswp:200901
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    References listed on IDEAS

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    1. Anil Bangia & Francis X. Diebold & Til Schuermann & John D. Stroughair, 1998. "Modeling Liquidity Risk With Implications for Traditional Market Risk Measurement and Management," New York University, Leonard N. Stern School Finance Department Working Paper Seires 99-062, New York University, Leonard N. Stern School of Business-.
    2. Umut Çetin & Robert A. Jarrow & Philip Protter, 2008. "Liquidity risk and arbitrage pricing theory," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 8, pages 153-183, World Scientific Publishing Co. Pte. Ltd..
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    5. Pierre Giot & Joachim Grammig, 2008. "How large is liquidity risk in an automated auction market?," Studies in Empirical Economics, in: Luc Bauwens & Winfried Pohlmeier & David Veredas (ed.), High Frequency Financial Econometrics, pages 111-131, Springer.
    6. 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.
    7. Bervas, A., 2006. "Market liquidity and its incorporation into risk management," Financial Stability Review, Banque de France, issue 8, pages 63-79, May.
    8. Robert Almgren, 2003. "Optimal execution with nonlinear impact functions and trading-enhanced risk," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(1), pages 1-18.
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    Citations

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    Cited by:

    1. Becchetti, L. & Ferrari, M. & Trenta, U., 2014. "The impact of the French Tobin tax," Journal of Financial Stability, Elsevier, vol. 15(C), pages 127-148.
    2. Holmberg, Ulf, 2012. "Essays on Credit Markets and Banking," Umeå Economic Studies 840, Umeå University, Department of Economics.
    3. Kylie-Anne Richards & Gareth W. Peters & William Dunsmuir, 2015. "Heavy-tailed features and dependence in limit order book volume profiles in futures markets," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 2(03), pages 1-56.
    4. Strašek Sebastjan & Bricelj Bor, 2016. "Spread and Liquidity Issues: A markets comparison," Naše gospodarstvo/Our economy, Sciendo, vol. 62(1), pages 3-11, March.

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    More about this item

    Keywords

    asset liquidity; liquidity cost; price impact; Xetra liquidity measure (XLM); risk measurement; Value-at-Risk; market liquidity risk;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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