Practical Applications from the Experts - June 2009

categories: Product Documentation, general

A new approach for measuring liquidity risk attempts to measures the additional market risk imposed by an orderly liquidation - that is, avoiding trading at a pace fast enough to move prices. The methodology supposes a liquidity horizon for individual holdings (either via trading volume or trader/risk manager’s intuition) – this is the number of trading days it would take to unwind a position without trading in enough size to adversely impact the market. The user can assign different liquidity horizons to different positions - for less liquid assets, exposure to potential market volatility can be longer (see Figure 1). The liquidation P&L Simulation then estimates the possible loss that would be incurred if the portfolio were completely liquidated with each position held to its liquidity horizon. This is done by generating scenarios for each bucket using the single characteristic liquidity horizon as the risk horizon (see Figure 2).

Figure 1

Figure 2

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