Modeling Liquidity Risk, With
Implications for Traditional
Market Risk Measurement and
Francis X. Diebold
John D. Stroughair
THE WHARTON FINANCIAL INSTITUTIONS CENTER
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Anthony M. Santomero
The Working Paper Series is made possible by a generous
grant from the Alfred P. Sloan Foundation
1Anil Bangia is at Oliver, Wyman & Company.
Francis X. Diebold is at the University of Pennsylvania, the Stern School, NYU, and the
Oliver Wyman Institute.
Til Schuermann is at Oliver, Wyman & Company.
John D. Stroughair is at Oliver, Wyman &Company.
We thank Steve Cecchetti and Edward Smith for helpful comments and suggestions. All
remaining errors are ours.
Modeling Liquidity Risk
With Implications for Traditional Market Risk Measurement and Management 1
This draft/print: December 21, 1998
Abstract: Market risk management under normal conditions traditionally has focussed on the
distribution of portfolio value changesresulting from moves in the mid-price. Hence the
market risk is really in a “pure” form: risk in an idealized market with no “friction” in
obtaining the fair price. However, many markets possess an additional liquidity component
that arises from a trader not realizing the mid-price when liquidating her position, but rather
the mid-price minus the bid-ask spread. We argue that liquidity risk associatedwith the
uncertainty of the spread, particularly for thinly traded or emerging market securities under
adverse market conditions, is an important part of overall risk and is therefore an important
component to model.
We develop a simple liquidity risk methodology that can be easily and seamlessly integrated
into standard value-at-risk models, and we show that ignoring the liquidity effect canproduce
underestimates of market risk in emerging markets by as much as 25-30%. Furthermore, we
show that the BIS inadvertently is already monitoring liquidity risk, and that by not modeling
it explicitly and therefore capitalizing against it, banks will be experiencing surprisingly many
violations of capital requirements, particularly if their portfolios are concentrated in emerging
-2-“Portfolios are usually marked to market at the middle of the bid-offer spread,
and many hedge funds used models that incorporated this assumption. In late
August, there was only one realistic value for the portfolio: the bid price.
Amid such massive sell-offs, only the first seller obtains a reasonable price for
its security; the rest loose a fortune by having to pay a liquidity premium
if they wanta sale. …Models should be revised to include bid-offer behaviour.”
Nicholas Dunbar (“Meriwether’s Meltdown,” Risk, October 1998, 32-36)
Недавний бепорядок на рынке ценных бумаг привел как экспертов так и непрофессионалов к тому, что они сочли виновным во всем риск потерь, связанных с трудностями в продаже активов. когда рынки истощились, и неопытные и умудренные опытом игроки были...