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On the White Board - July 2008
Jul 15, 2008
In the March issue of the RiskMetrics Research Monthly, I echoed the feeling of the Senior Supervisors Group that not enough had been done in developing methods to address liquidity risk. Moreover, it is important with liquidity that we not let the perfect be the enemy of the good and that we simply get started. Since that time, two lengthy documents on liquidity have crossed my desk. One is the Basel Committee's Principles for Sound Liquidity Risk Management and Supervision. The focus of the paper is purely on funding liquidity risk, that is, the risk that a firm is unable to meet its own cash flow needs. It is a consultative paper, stipulating broad principles, all of which serve to place liquidity at a position of greater attention, but none of which are detailed enough yet to be particularly controversial. The second paper, Liquidity and Leverage by Tobias Adrian of the New York Fed and Hyun Song Shin of Princeton University, discusses market liquidity, in particular the interaction between dealer balance sheet size, dealer leverage, and market volatility. Most interesting to me are the various data sources the authors use to investigate these relationships empirically, including the Federal Reserve's aggregated data on primary dealer repo activity. On a dashboard of overall market liquidity, this information seems to merit some space.