Seminar abstract
Review of Market Liquidity Risk Measurement Models
Presented By: Kishore Rathi, EFPM 2008-12
Seminar Guide: Dr H K Pradhan
Abstract
Liquidity has been a very elusive topic with very little academic research coverage in Modern Finance. Cohesive definition of this phenomena is far from agreed upon. On the outset liquidity, with a number of dimensions and perspectives, presents a zig-saw puzzle of a common anticipation of uncertain worst loss. This loss is to be incurred while liquidating a large portfolio in want of cash. Financial debacles like Black Monday (1987), Asian Crisis(1997), LTCM (1998), Russian Bond Crisis(1998), Amaranth(2006), subprime MBS/CDO(2008) and others prompted much needed coverage on this topic. Institutions, Regulators, and Investors alike all prefer to have a measure which can be integrated in their day to day decision making keeping the financial risk management in control. Keeping this in mind liquidity research coverage has been on the VaR line of thinking. VaR oriented thinking has prevailed in prominence because of its simplistic interpretation and ease of computation in spite of it being not a coherent measure of risk. This paper reviews various prevalent empirical and theoretical models to measure market liquidity risk. Empirical models use various aspects of Bid-Ask spread and volume to determine the price impact of liquidation and factor the adverse impact in VaR calculation. The theoretical models tend to minimize the price impact by focusing on optimal execution strategy based on Demand-Supply curve. Though empirical tractability and parameter estimation of the theoretical models is yet to be accomplished. All the models tend to achieve a single measure which can be added to the existing risk measurement framework.
Keywords: Liquidity, Market Liquidity, Liquidity Cost, Bid-Ask Spread, Weighted Bid-Ask Spread, Market Depth, Price Impact, Optimal Execution Strategy, Optimal Holding Period, Market Risk, VaR, lVaR.
JEL
Presented By: Kishore Rathi, EFPM 2008-12
Seminar Guide: Dr H K Pradhan
Abstract
Liquidity has been a very elusive topic with very little academic research coverage in Modern Finance. Cohesive definition of this phenomena is far from agreed upon. On the outset liquidity, with a number of dimensions and perspectives, presents a zig-saw puzzle of a common anticipation of uncertain worst loss. This loss is to be incurred while liquidating a large portfolio in want of cash. Financial debacles like Black Monday (1987), Asian Crisis(1997), LTCM (1998), Russian Bond Crisis(1998), Amaranth(2006), subprime MBS/CDO(2008) and others prompted much needed coverage on this topic. Institutions, Regulators, and Investors alike all prefer to have a measure which can be integrated in their day to day decision making keeping the financial risk management in control. Keeping this in mind liquidity research coverage has been on the VaR line of thinking. VaR oriented thinking has prevailed in prominence because of its simplistic interpretation and ease of computation in spite of it being not a coherent measure of risk. This paper reviews various prevalent empirical and theoretical models to measure market liquidity risk. Empirical models use various aspects of Bid-Ask spread and volume to determine the price impact of liquidation and factor the adverse impact in VaR calculation. The theoretical models tend to minimize the price impact by focusing on optimal execution strategy based on Demand-Supply curve. Though empirical tractability and parameter estimation of the theoretical models is yet to be accomplished. All the models tend to achieve a single measure which can be added to the existing risk measurement framework.
Keywords: Liquidity, Market Liquidity, Liquidity Cost, Bid-Ask Spread, Weighted Bid-Ask Spread, Market Depth, Price Impact, Optimal Execution Strategy, Optimal Holding Period, Market Risk, VaR, lVaR.
JEL