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Liquidity Stress Testing in Asset Management - Part 2. Modeling the Asset Liquidity Risk

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  • Roncalli, Thierry
  • Cherief, Amina
  • Karray-Meziou, Fatma
  • Regnault, Margaux

Abstract

This article is part of a comprehensive research project on liquidity risk in asset management, which can be divided into three dimensions. The first dimension covers liability liquidity risk (or funding liquidity) modeling, the second dimension focuses on asset liquidity risk (or market liquidity) modeling, and the third dimension considers the asset-liability management of the liquidity gap risk (or asset-liability matching). The purpose of this research is to propose a methodological and practical framework in order to perform liquidity stress testing programs, which comply with regulatory guidelines (ESMA, 2019, 2020) and are useful for fund managers. The review of the academic literature and professional research studies shows that there is a lack of standardized and analytical models. The aim of this research project is then to fill the gap with the goal of developing mathematical and statistical approaches, and providing appropriate answers. In this second article focused on asset liquidity risk modeling, we propose a market impact model to estimate transaction costs. After presenting a toy model that helps to understand the main concepts of asset liquidity, we consider a two-regime model, which is based on the power-law property of price impact. Then, we define several asset liquidity measures such as liquidity cost, liquidation ratio and shortfall or time to liquidation in order to assess the different dimensions of asset liquidity. Finally, we apply this asset liquidity framework to stocks and bonds and discuss the issues of calibrating the transaction cost model.

Suggested Citation

  • Roncalli, Thierry & Cherief, Amina & Karray-Meziou, Fatma & Regnault, Margaux, 2021. "Liquidity Stress Testing in Asset Management - Part 2. Modeling the Asset Liquidity Risk," MPRA Paper 108295, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:108295
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    File URL: https://mpra.ub.uni-muenchen.de/108295/1/Liquidity_Stress_Testing_Part_Two.pdf
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    References listed on IDEAS

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    Cited by:

    1. Thierry Roncalli, 2021. "Liquidity Stress Testing in Asset Management -- Part 3. Managing the Asset-Liability Liquidity Risk," Papers 2110.01302, arXiv.org.

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    More about this item

    Keywords

    Asset liquidity; stress testing; bid-ask spread; market impact; transaction cost; participation rate; power law; liquidation cost; liquidation ratio; liquidation shortfall; time to liquidation;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • 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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